Is Kaitori Okoku (TYO:3181) A Risky Investment?

Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' 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 can see that Kaitori Okoku Co., Ltd. (TYO:3181) does use debt in its business. But the more important question is: how much risk is that debt creating?

What Risk Does Debt Bring?

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 common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. 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.

Check out our latest analysis for Kaitori Okoku

What Is Kaitori Okoku's Debt?

As you can see below, Kaitori Okoku had JP¥917.0m of debt at November 2020, down from JP¥1.01b a year prior. But it also has JP¥948.0m in cash to offset that, meaning it has JP¥31.0m net cash.

A Look At Kaitori Okoku's Liabilities

Zooming in on the latest balance sheet data, we can see that Kaitori Okoku had liabilities of JP¥681.0m due within 12 months and liabilities of JP¥690.0m due beyond that. Offsetting these obligations, it had cash of JP¥948.0m as well as receivables valued at JP¥127.0m due within 12 months. So its liabilities total JP¥296.0m more than the combination of its cash and short-term receivables.

While this might seem like a lot, it is not so bad since Kaitori Okoku has a market capitalization of JP¥1.12b, and so it could probably strengthen its balance sheet by raising capital if it needed to. But it's clear that we should definitely closely examine whether it can manage its debt without dilution. Despite its noteworthy liabilities, Kaitori Okoku boasts net cash, so it's fair to say it does not have a heavy debt load!

In addition to that, we're happy to report that Kaitori Okoku has boosted its EBIT by 43%, thus reducing the spectre of future debt repayments. When analysing debt levels, the balance sheet is the obvious place to start. But it is Kaitori Okoku'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.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. While Kaitori Okoku has net cash on its balance sheet, it's still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. Happily for any shareholders, Kaitori Okoku actually produced more free cash flow than EBIT over the last three years. That sort of strong cash conversion gets us as excited as the crowd when the beat drops at a Daft Punk concert.

Summing up

Although Kaitori Okoku's balance sheet isn't particularly strong, due to the total liabilities, it is clearly positive to see that it has net cash of JP¥31.0m. The cherry on top was that in converted 152% of that EBIT to free cash flow, bringing in JP¥288m. So is Kaitori Okoku's debt a risk? It doesn't seem so to us. 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. These risks can be hard to spot. Every company has them, and we've spotted 2 warning signs for Kaitori Okoku you should know about.

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

If you decide to trade Kaitori Okoku, use the lowest-cost* platform that is rated #1 Overall by Barron’s, Interactive Brokers. Trade stocks, options, futures, forex, bonds and funds on 135 markets, all from a single integrated account. Promoted

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.
^*Interactive Brokers Rated Lowest Cost Broker by StockBrokers.com Annual Online Review 2020

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.