Health Check: How Prudently Does T.Kawabe (TYO:8123) Use Debt?

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. As with many other companies T.Kawabe & Co., Ltd. (TYO:8123) makes use of debt. But is this debt a concern to shareholders?

When Is Debt A Problem?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. If things get really bad, the lenders can take control of the business. 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. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

View our latest analysis for T.Kawabe

What Is T.Kawabe's Debt?

You can click the graphic below for the historical numbers, but it shows that as of September 2020 T.Kawabe had JP¥3.02b of debt, an increase on JP¥2.74b, over one year. However, it also had JP¥1.36b in cash, and so its net debt is JP¥1.66b.

A Look At T.Kawabe's Liabilities

According to the last reported balance sheet, T.Kawabe had liabilities of JP¥4.65b due within 12 months, and liabilities of JP¥1.33b due beyond 12 months. Offsetting this, it had JP¥1.36b in cash and JP¥1.41b in receivables that were due within 12 months. So its liabilities total JP¥3.21b more than the combination of its cash and short-term receivables.

When you consider that this deficiency exceeds the company's JP¥2.24b market capitalization, you might well be inclined to review the balance sheet intently. In the scenario where the company had to clean up its balance sheet quickly, it seems likely shareholders would suffer extensive dilution. There's no doubt that we learn most about debt from the balance sheet. But it is T.Kawabe'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.

Over 12 months, T.Kawabe made a loss at the EBIT level, and saw its revenue drop to JP¥13b, which is a fall of 21%. That makes us nervous, to say the least.

Caveat Emptor

While T.Kawabe's falling revenue is about as heartwarming as a wet blanket, arguably its earnings before interest and tax (EBIT) loss is even less appealing. Indeed, it lost a very considerable JP¥283m at the EBIT level. When we look at that alongside the significant liabilities, we're not particularly confident about the company. It would need to improve its operations quickly for us to be interested in it. Not least because it had negative free cash flow of JP¥535m over the last twelve months. That means it's on the risky side of things. 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. To that end, you should learn about the 5 warning signs we've spotted with T.Kawabe (including 2 which don't sit too well with us) .

At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.

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