Apple International (TSE:2788) Takes On Some Risk With Its Use Of Debt

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.' 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. We can see that Apple International Co., Ltd. (TSE:2788) does use debt in its business. But should shareholders be worried about its use of debt?

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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we examine debt levels, we first consider both cash and debt levels, together.

Check out our latest analysis for Apple International

What Is Apple International's Debt?

You can click the graphic below for the historical numbers, but it shows that as of March 2024 Apple International had JP¥8.31b of debt, an increase on JP¥7.61b, over one year. However, it also had JP¥2.91b in cash, and so its net debt is JP¥5.40b.

A Look At Apple International's Liabilities

The latest balance sheet data shows that Apple International had liabilities of JP¥7.97b due within a year, and liabilities of JP¥2.22b falling due after that. Offsetting this, it had JP¥2.91b in cash and JP¥6.21b in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by JP¥1.06b.

Of course, Apple International has a market capitalization of JP¥6.81b, so these liabilities are probably manageable. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time.

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.

Apple International has a debt to EBITDA ratio of 4.3, which signals significant debt, but is still pretty reasonable for most types of business. However, its interest coverage of 25.7 is very high, suggesting that the interest expense on the debt is currently quite low. Shareholders should be aware that Apple International's EBIT was down 28% last year. If that earnings trend continues then paying off its debt will be about as easy as herding cats on to a roller coaster. 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 Apple International 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 business needs free cash flow to pay off debt; accounting profits just don't cut it. So the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. Looking at the most recent three years, Apple International recorded free cash flow of 39% of its EBIT, which is weaker than we'd expect. That's not great, when it comes to paying down debt.

Our View

Neither Apple International's ability to grow its EBIT nor its net debt to EBITDA gave us confidence in its ability to take on more debt. But its interest cover tells a very different story, and suggests some resilience. Taking the abovementioned factors together we do think Apple International's debt poses some risks to the business. So while that leverage does boost returns on equity, we wouldn't really want to see it increase from here. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. We've identified 6 warning signs with Apple International (at least 1 which is a bit unpleasant) , and understanding them should be part of your investment process.

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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This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. 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.