Here's Why AzplanningLtd (TYO:3490) Has A Meaningful Debt Burden

Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. We note that Azplanning Co.,Ltd. (TYO:3490) does have debt on its balance sheet. But the real question is whether this debt is making the company risky.

Why Does Debt Bring Risk?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. Of course, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

View our latest analysis for AzplanningLtd

How Much Debt Does AzplanningLtd Carry?

As you can see below, AzplanningLtd had JP¥3.71b of debt at November 2020, down from JP¥5.64b a year prior. On the flip side, it has JP¥2.40b in cash leading to net debt of about JP¥1.31b.

How Healthy Is AzplanningLtd's Balance Sheet?

According to the last reported balance sheet, AzplanningLtd had liabilities of JP¥1.07b due within 12 months, and liabilities of JP¥3.31b due beyond 12 months. Offsetting this, it had JP¥2.40b in cash and JP¥20.0m in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by JP¥1.95b.

This deficit casts a shadow over the JP¥1.28b company, like a colossus towering over mere mortals. So we definitely think shareholders need to watch this one closely. At the end of the day, AzplanningLtd would probably need a major re-capitalization if its creditors were to demand repayment.

We measure a company's debt load relative to its earnings power by looking at its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and by calculating how easily its earnings before interest and tax (EBIT) cover its interest expense (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).

AzplanningLtd has a debt to EBITDA ratio of 3.9 and its EBIT covered its interest expense 5.2 times. This suggests that while the debt levels are significant, we'd stop short of calling them problematic. Pleasingly, AzplanningLtd is growing its EBIT faster than former Australian PM Bob Hawke downs a yard glass, boasting a 209% gain in the last twelve months. There's no doubt that we learn most about debt from the balance sheet. But it is AzplanningLtd's earnings that will influence how the balance sheet holds up in the future. 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, a business needs free cash flow to pay off debt; accounting profits just don't cut it. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. During the last three years, AzplanningLtd burned a lot of cash. While investors are no doubt expecting a reversal of that situation in due course, it clearly does mean its use of debt is more risky.

Our View

On the face of it, AzplanningLtd's level of total liabilities left us tentative about the stock, and its conversion of EBIT to free cash flow was no more enticing than the one empty restaurant on the busiest night of the year. But on the bright side, its EBIT growth rate is a good sign, and makes us more optimistic. Overall, it seems to us that AzplanningLtd's balance sheet is really quite a risk to the business. So we're almost as wary of this stock as a hungry kitten is about falling into its owner's fish pond: once bitten, twice shy, as they say. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. For example, we've discovered 3 warning signs for AzplanningLtd (1 is a bit unpleasant!) 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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