Japan Publications Trading (TYO:8072) Seems To Use Debt Quite Sensibly

The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. We note that Japan Publications Trading Co., Ltd. (TYO:8072) does have debt on its balance sheet. But is this debt a concern to shareholders?

Why Does Debt Bring Risk?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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, 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.

See our latest analysis for Japan Publications Trading

What Is Japan Publications Trading's Net Debt?

You can click the graphic below for the historical numbers, but it shows that as of December 2020 Japan Publications Trading had JP¥1.30b of debt, an increase on JP¥1.03b, over one year. However, it also had JP¥710.0m in cash, and so its net debt is JP¥587.0m.

How Strong Is Japan Publications Trading's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Japan Publications Trading had liabilities of JP¥2.46b due within 12 months and liabilities of JP¥631.0m due beyond that. Offsetting this, it had JP¥710.0m in cash and JP¥1.43b in receivables that were due within 12 months. So its liabilities total JP¥953.0m more than the combination of its cash and short-term receivables.

Given this deficit is actually higher than the company's market capitalization of JP¥901.0m, we think shareholders really should watch Japan Publications Trading's debt levels, like a parent watching their child ride a bike for the first time. In the scenario where the company had to clean up its balance sheet quickly, it seems likely shareholders would suffer extensive dilution.

In order to size up a company's debt relative to its earnings, we calculate its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and its earnings before interest and tax (EBIT) divided by its interest expense (its interest cover). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

Japan Publications Trading's net debt to EBITDA ratio of about 2.5 suggests only moderate use of debt. And its strong interest cover of 47.3 times, makes us even more comfortable. It is well worth noting that Japan Publications Trading's EBIT shot up like bamboo after rain, gaining 42% in the last twelve months. That'll make it easier to manage 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 Japan Publications Trading 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.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. So the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. Happily for any shareholders, Japan Publications Trading actually produced more free cash flow than EBIT over the last three years. That sort of strong cash generation warms our hearts like a puppy in a bumblebee suit.

Our View

Happily, Japan Publications Trading's impressive interest cover implies it has the upper hand on its debt. But we must concede we find its level of total liabilities has the opposite effect. Looking at all the aforementioned factors together, it strikes us that Japan Publications Trading can handle its debt fairly comfortably. Of course, while this leverage can enhance returns on equity, it does bring more risk, so it's worth keeping an eye on this one. 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. For example, we've discovered 3 warning signs for Japan Publications Trading (1 is potentially serious!) that you should be aware of before investing here.

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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