Does MarketEnterpriseLtd (TSE:3135) Have A Healthy Balance Sheet?

Warren Buffett famously said, 'Volatility is far from synonymous with risk.' 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, MarketEnterprise Co.,Ltd (TSE:3135) does carry debt. But should shareholders be worried about its use of debt?

What Risk Does Debt Bring?

Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. 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, plenty of companies use debt to fund growth, without any negative consequences. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

See our latest analysis for MarketEnterpriseLtd

What Is MarketEnterpriseLtd's Net Debt?

As you can see below, at the end of December 2023, MarketEnterpriseLtd had JP¥2.25b of debt, up from JP¥1.88b a year ago. Click the image for more detail. However, it also had JP¥1.52b in cash, and so its net debt is JP¥730.0m.

How Healthy Is MarketEnterpriseLtd's Balance Sheet?

According to the last reported balance sheet, MarketEnterpriseLtd had liabilities of JP¥3.50b due within 12 months, and liabilities of JP¥75.0m due beyond 12 months. On the other hand, it had cash of JP¥1.52b and JP¥1.22b worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by JP¥837.0m.

This deficit isn't so bad because MarketEnterpriseLtd is worth JP¥3.76b, and thus could probably raise enough capital to shore up its balance sheet, if the need arose. But it's clear that we should definitely closely examine whether it can manage its debt without 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). The advantage of this approach is that we take into account both the absolute quantum of debt (with net debt to EBITDA) and the actual interest expenses associated with that debt (with its interest cover ratio).

MarketEnterpriseLtd's debt is 3.0 times its EBITDA, and its EBIT cover its interest expense 5.7 times over. Taken together this implies that, while we wouldn't want to see debt levels rise, we think it can handle its current leverage. We also note that MarketEnterpriseLtd improved its EBIT from a last year's loss to a positive JP¥97m. When analysing debt levels, the balance sheet is the obvious place to start. But it is MarketEnterpriseLtd's earnings that will influence how the balance sheet holds up in the future. 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. So it's worth checking how much of the earnings before interest and tax (EBIT) is backed by free cash flow. During the last year, MarketEnterpriseLtd burned a lot of cash. While that may be a result of expenditure for growth, it does make the debt far more risky.

Our View

MarketEnterpriseLtd's struggle to convert EBIT to free cash flow had us second guessing its balance sheet strength, but the other data-points we considered were relatively redeeming. For example, its interest cover is relatively strong. Taking the abovementioned factors together we do think MarketEnterpriseLtd'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. However, not all investment risk resides within the balance sheet - far from it. Be aware that MarketEnterpriseLtd is showing 4 warning signs in our investment analysis , and 2 of those are potentially serious...

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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

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.