SaftecLtd (TYO:7464) Could Easily Take On More Debt

David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the permanent loss of capital.' 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. Importantly, Saftec Co.,Ltd. (TYO:7464) does carry debt. But the real question is whether this debt is making the company risky.

When Is Debt Dangerous?

Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. When we think about a company's use of debt, we first look at cash and debt together.

View our latest analysis for SaftecLtd

What Is SaftecLtd's Debt?

As you can see below, SaftecLtd had JP¥2.94b of debt at September 2020, down from JP¥3.20b a year prior. However, it does have JP¥3.11b in cash offsetting this, leading to net cash of JP¥165.0m.

How Healthy Is SaftecLtd's Balance Sheet?

We can see from the most recent balance sheet that SaftecLtd had liabilities of JP¥4.12b falling due within a year, and liabilities of JP¥1.78b due beyond that. On the other hand, it had cash of JP¥3.11b and JP¥2.53b worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by JP¥264.0m.

Since publicly traded SaftecLtd shares are worth a total of JP¥4.40b, it seems unlikely that this level of liabilities would be a major threat. But there are sufficient liabilities that we would certainly recommend shareholders continue to monitor the balance sheet, going forward. While it does have liabilities worth noting, SaftecLtd also has more cash than debt, so we're pretty confident it can manage its debt safely.

And we also note warmly that SaftecLtd grew its EBIT by 15% last year, making its debt load easier to handle. The balance sheet is clearly the area to focus on when you are analysing debt. But it is SaftecLtd'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. While SaftecLtd 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. During the last three years, SaftecLtd generated free cash flow amounting to a very robust 84% of its EBIT, more than we'd expect. That puts it in a very strong position to pay down debt.

Summing up

While it is always sensible to look at a company's total liabilities, it is very reassuring that SaftecLtd has JP¥165.0m in net cash. The cherry on top was that in converted 84% of that EBIT to free cash flow, bringing in JP¥1.1b. So is SaftecLtd'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. Consider risks, for instance. Every company has them, and we've spotted 2 warning signs for SaftecLtd you should know about.

When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.

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