Handsman (TYO:7636) Seems To Use Debt Rather Sparingly

Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' So it seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. We can see that Handsman Co., Ltd. (TYO:7636) does use debt in its business. But the real question is whether this debt is making the company risky.

What Risk Does Debt Bring?

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. 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. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. When we examine debt levels, we first consider both cash and debt levels, together.

View our latest analysis for Handsman

How Much Debt Does Handsman Carry?

You can click the graphic below for the historical numbers, but it shows that Handsman had JP¥400.0m of debt in December 2020, down from JP¥1.13b, one year before. But it also has JP¥3.40b in cash to offset that, meaning it has JP¥3.00b net cash.

A Look At Handsman's Liabilities

Zooming in on the latest balance sheet data, we can see that Handsman had liabilities of JP¥4.37b due within 12 months and liabilities of JP¥855.0m due beyond that. On the other hand, it had cash of JP¥3.40b and JP¥528.0m worth of receivables due within a year. So it has liabilities totalling JP¥1.30b more than its cash and near-term receivables, combined.

Given Handsman has a market capitalization of JP¥26.8b, it's hard to believe these liabilities pose much threat. But there are sufficient liabilities that we would certainly recommend shareholders continue to monitor the balance sheet, going forward. Despite its noteworthy liabilities, Handsman boasts net cash, so it's fair to say it does not have a heavy debt load!

On top of that, Handsman grew its EBIT by 37% over the last twelve months, and that growth will make it easier to handle its debt. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since Handsman 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. Handsman 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. During the last three years, Handsman generated free cash flow amounting to a very robust 93% of its EBIT, more than we'd expect. That puts it in a very strong position to pay down debt.

Summing up

We could understand if investors are concerned about Handsman's liabilities, but we can be reassured by the fact it has has net cash of JP¥3.00b. The cherry on top was that in converted 93% of that EBIT to free cash flow, bringing in JP¥2.7b. So we don't think Handsman's use of debt is risky. Over time, share prices tend to follow earnings per share, so if you're interested in Handsman, you may well want to click here to check an interactive graph of its earnings per share history.

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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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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