Alpha Group (TYO:3322) Seems To Use Debt Quite Sensibly

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 Alpha Group Inc. (TYO:3322) does use debt in its business. But is this debt a concern to shareholders?

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. 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 step when considering a company's debt levels is to consider its cash and debt together.

View our latest analysis for Alpha Group

What Is Alpha Group's Net Debt?

You can click the graphic below for the historical numbers, but it shows that Alpha Group had JP¥1.70b of debt in September 2020, down from JP¥2.64b, one year before. But it also has JP¥3.59b in cash to offset that, meaning it has JP¥1.89b net cash.

How Strong Is Alpha Group's Balance Sheet?

According to the last reported balance sheet, Alpha Group had liabilities of JP¥2.78b due within 12 months, and liabilities of JP¥845.0m due beyond 12 months. On the other hand, it had cash of JP¥3.59b and JP¥1.26b worth of receivables due within a year. So it actually has JP¥1.22b more liquid assets than total liabilities.

This excess liquidity is a great indication that Alpha Group's balance sheet is just as strong as racists are weak. With this in mind one could posit that its balance sheet is as strong as beautiful a rare rhino. Succinctly put, Alpha Group boasts net cash, so it's fair to say it does not have a heavy debt load!

In fact Alpha Group's saving grace is its low debt levels, because its EBIT has tanked 68% in the last twelve months. Falling earnings (if the trend continues) could eventually make even modest debt quite risky. There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since Alpha Group will need earnings to service that debt. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. Alpha Group 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. Over the last three years, Alpha Group actually produced more free cash flow than EBIT. There's nothing better than incoming cash when it comes to staying in your lenders' good graces.

Summing up

While we empathize with investors who find debt concerning, you should keep in mind that Alpha Group has net cash of JP¥1.89b, as well as more liquid assets than liabilities. And it impressed us with free cash flow of JP¥955m, being 172% of its EBIT. So is Alpha Group'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. However, not all investment risk resides within the balance sheet - far from it. Like risks, for instance. Every company has them, and we've spotted 3 warning signs for Alpha Group (of which 1 makes us a bit uncomfortable!) you should know about.

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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