Here's Why ToubujyuhanLtd (TYO:3297) Can Manage Its Debt Responsibly

David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the permanent loss of capital.' So it seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. As with many other companies Toubujyuhan Co.,Ltd. (TYO:3297) makes use of debt. But is this debt a concern to shareholders?

Why Does Debt Bring Risk?

Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. The first step when considering a company's debt levels is to consider its cash and debt together.

See our latest analysis for ToubujyuhanLtd

What Is ToubujyuhanLtd's Net Debt?

As you can see below, ToubujyuhanLtd had JP¥1.38b of debt at November 2020, down from JP¥1.53b a year prior. However, because it has a cash reserve of JP¥1.14b, its net debt is less, at about JP¥244.0m.

How Healthy Is ToubujyuhanLtd's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that ToubujyuhanLtd had liabilities of JP¥1.62b due within 12 months and liabilities of JP¥446.0m due beyond that. On the other hand, it had cash of JP¥1.14b and JP¥36.0m worth of receivables due within a year. So its liabilities total JP¥889.0m more than the combination of its cash and short-term receivables.

This deficit isn't so bad because ToubujyuhanLtd is worth JP¥3.40b, and thus could probably raise enough capital to shore up its balance sheet, if the need arose. However, it is still worthwhile taking a close look at its ability to pay off debt.

In order to size up a company's debt relative to its earnings, we calculate its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and its earnings before interest and tax (EBIT) divided by its interest expense (its interest cover). The advantage of this approach is that we take into account both the absolute quantum of debt (with net debt to EBITDA) and the actual interest expenses associated with that debt (with its interest cover ratio).

ToubujyuhanLtd's net debt is only 0.42 times its EBITDA. And its EBIT easily covers its interest expense, being 104 times the size. So you could argue it is no more threatened by its debt than an elephant is by a mouse. And we also note warmly that ToubujyuhanLtd grew its EBIT by 16% last year, making its debt load easier to handle. There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since ToubujyuhanLtd will need earnings to service that debt. So if you're keen to discover more about its earnings, it might be worth checking out this graph of its long term earnings trend.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So it's worth checking how much of that EBIT is backed by free cash flow. Looking at the most recent three years, ToubujyuhanLtd recorded free cash flow of 30% of its EBIT, which is weaker than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.

Our View

ToubujyuhanLtd's interest cover suggests it can handle its debt as easily as Cristiano Ronaldo could score a goal against an under 14's goalkeeper. But truth be told we feel its conversion of EBIT to free cash flow does undermine this impression a bit. All these things considered, it appears that ToubujyuhanLtd can comfortably handle its current debt levels. Of course, while this leverage can enhance returns on equity, it does bring more risk, so it's worth keeping an eye on this one. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. For example, we've discovered 3 warning signs for ToubujyuhanLtd (1 is potentially serious!) that you should be aware of before investing here.

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

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This article by Simply Wall St is general in nature. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.
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