TENPOS HOLDINGSLtd (TYO:2751) Seems To Use Debt Quite Sensibly

The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. Importantly, TENPOS HOLDINGS Co.,Ltd. (TYO:2751) does carry debt. But the real question is whether this debt is making the company risky.

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. If things get really bad, the lenders can take control of the business. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we think about a company's use of debt, we first look at cash and debt together.

See our latest analysis for TENPOS HOLDINGSLtd

What Is TENPOS HOLDINGSLtd's Net Debt?

As you can see below, at the end of October 2020, TENPOS HOLDINGSLtd had JP¥699.0m of debt, up from none a year ago. Click the image for more detail. But on the other hand it also has JP¥7.69b in cash, leading to a JP¥7.00b net cash position.

How Healthy Is TENPOS HOLDINGSLtd's Balance Sheet?

We can see from the most recent balance sheet that TENPOS HOLDINGSLtd had liabilities of JP¥4.18b falling due within a year, and liabilities of JP¥774.0m due beyond that. Offsetting these obligations, it had cash of JP¥7.69b as well as receivables valued at JP¥1.21b due within 12 months. So it actually has JP¥3.95b more liquid assets than total liabilities.

This surplus suggests that TENPOS HOLDINGSLtd is using debt in a way that is appears to be both safe and conservative. Due to its strong net asset position, it is not likely to face issues with its lenders. Succinctly put, TENPOS HOLDINGSLtd boasts net cash, so it's fair to say it does not have a heavy debt load!

It is just as well that TENPOS HOLDINGSLtd's load is not too heavy, because its EBIT was down 63% over the last year. Falling earnings (if the trend continues) could eventually make even modest debt quite risky. When analysing debt levels, the balance sheet is the obvious place to start. But it is TENPOS HOLDINGSLtd's earnings that will influence how the balance sheet holds up in the future. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. TENPOS HOLDINGSLtd may have net cash on the balance sheet, but it is still interesting to look at how well the business converts its earnings before interest and tax (EBIT) to free cash flow, because that will influence both its need for, and its capacity to manage debt. Looking at the most recent three years, TENPOS HOLDINGSLtd recorded free cash flow of 45% of its EBIT, which is weaker than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.

Summing up

While we empathize with investors who find debt concerning, you should keep in mind that TENPOS HOLDINGSLtd has net cash of JP¥7.00b, as well as more liquid assets than liabilities. So we are not troubled with TENPOS HOLDINGSLtd's debt use. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. For instance, we've identified 3 warning signs for TENPOS HOLDINGSLtd (1 is significant) you should be aware of.

If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.

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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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