Kaitori Okoku (TYO:3181) Seems To Use Debt Rather Sparingly

Warren Buffett famously said, 'Volatility is far from synonymous with risk.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. We can see that Kaitori Okoku Co., Ltd. (TYO:3181) does use debt in its business. 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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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, debt can be an important tool in businesses, particularly capital heavy businesses. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

Check out our latest analysis for Kaitori Okoku

What Is Kaitori Okoku's Net Debt?

The image below, which you can click on for greater detail, shows that at August 2020 Kaitori Okoku had debt of JP¥1.01b, up from JP¥912.0m in one year. But it also has JP¥1.06b in cash to offset that, meaning it has JP¥52.0m net cash.

A Look At Kaitori Okoku's Liabilities

We can see from the most recent balance sheet that Kaitori Okoku had liabilities of JP¥682.0m falling due within a year, and liabilities of JP¥767.0m due beyond that. Offsetting this, it had JP¥1.06b in cash and JP¥101.0m in receivables that were due within 12 months. So its liabilities total JP¥286.0m more than the combination of its cash and short-term receivables.

This deficit isn't so bad because Kaitori Okoku is worth JP¥1.06b, 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. While it does have liabilities worth noting, Kaitori Okoku also has more cash than debt, so we're pretty confident it can manage its debt safely.

On top of that, Kaitori Okoku grew its EBIT by 88% over the last twelve months, and that growth will make it easier to handle its debt. The balance sheet is clearly the area to focus on when you are analysing debt. But you can't view debt in total isolation; since Kaitori Okoku 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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. 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. Over the last three years, Kaitori Okoku actually produced more free cash flow than EBIT. That sort of strong cash generation warms our hearts like a puppy in a bumblebee suit.

Summing up

While Kaitori Okoku does have more liabilities than liquid assets, it also has net cash of JP¥52.0m. The cherry on top was that in converted 142% of that EBIT to free cash flow, bringing in JP¥288m. So we don't think Kaitori Okoku's use of debt is risky. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. For instance, we've identified 4 warning signs for Kaitori Okoku (1 is a bit concerning) you should be aware of.

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.

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