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. As with many other companies MarketEnterprise Co.,Ltd (TSE:3135) makes use of debt. But the real question is whether this debt is making the company risky.
When Is Debt A Problem?
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. 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. 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 thing to do when considering how much debt a business uses is to look at its cash and debt together.
Check out our latest analysis for MarketEnterpriseLtd
What Is MarketEnterpriseLtd's Debt?
The image below, which you can click on for greater detail, shows that at March 2024 MarketEnterpriseLtd had debt of JP¥2.36b, up from JP¥1.81b in one year. However, because it has a cash reserve of JP¥1.62b, its net debt is less, at about JP¥738.0m.
How Strong Is MarketEnterpriseLtd's Balance Sheet?
According to the last reported balance sheet, MarketEnterpriseLtd had liabilities of JP¥3.87b due within 12 months, and liabilities of JP¥66.0m due beyond 12 months. On the other hand, it had cash of JP¥1.62b and JP¥1.52b worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by JP¥796.0m.
Given MarketEnterpriseLtd has a market capitalization of JP¥4.53b, it's hard to believe these liabilities pose much threat. Having said that, it's clear that we should continue to monitor its balance sheet, lest it change for the worse.
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.
With a debt to EBITDA ratio of 2.4, MarketEnterpriseLtd uses debt artfully but responsibly. And the fact that its trailing twelve months of EBIT was 8.5 times its interest expenses harmonizes with that theme. Notably, MarketEnterpriseLtd made a loss at the EBIT level, last year, but improved that to positive EBIT of JP¥161m in the last twelve months. The balance sheet is clearly the area to focus on when you are analysing debt. But it is MarketEnterpriseLtd'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.
But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So it is important to check how much of its earnings before interest and tax (EBIT) converts to actual 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 conversion of EBIT to free cash flow was a real negative on this analysis, although the other factors we considered cast it in a significantly better light. But on the bright side, its ability to to cover its interest expense with its EBIT isn't too shabby at all. Taking the abovementioned factors together we do think MarketEnterpriseLtd's debt poses some risks to the business. While that debt can boost returns, we think the company has enough leverage now. 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. These risks can be hard to spot. Every company has them, and we've spotted 3 warning signs for MarketEnterpriseLtd (of which 2 shouldn't be ignored!) you should know about.
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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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.
Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team@simplywallst.com
About TSE:3135
Adequate balance sheet low.
