International Conglomerate of Distribution for Automobile Holdings (TSE:3184) Has A Somewhat Strained Balance Sheet

Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' 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 International Conglomerate of Distribution for Automobile Holdings Co., Ltd. (TSE:3184) does use debt in its business. But is this debt a concern to shareholders?

When Is Debt Dangerous?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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. When we think about a company's use of debt, we first look at cash and debt together.

View our latest analysis for International Conglomerate of Distribution for Automobile Holdings

What Is International Conglomerate of Distribution for Automobile Holdings's Net Debt?

As you can see below, at the end of March 2024, International Conglomerate of Distribution for Automobile Holdings had JP¥3.31b of debt, up from JP¥1.50b a year ago. Click the image for more detail. However, because it has a cash reserve of JP¥840.0m, its net debt is less, at about JP¥2.47b.

A Look At International Conglomerate of Distribution for Automobile Holdings' Liabilities

Zooming in on the latest balance sheet data, we can see that International Conglomerate of Distribution for Automobile Holdings had liabilities of JP¥9.15b due within 12 months and liabilities of JP¥1.16b due beyond that. Offsetting these obligations, it had cash of JP¥840.0m as well as receivables valued at JP¥744.0m due within 12 months. So it has liabilities totalling JP¥8.72b more than its cash and near-term receivables, combined.

This deficit casts a shadow over the JP¥5.33b company, like a colossus towering over mere mortals. So we'd watch its balance sheet closely, without a doubt. After all, International Conglomerate of Distribution for Automobile Holdings would likely require a major re-capitalisation if it had to pay its creditors today.

We measure a company's debt load relative to its earnings power by looking at its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and by calculating how easily its earnings before interest and tax (EBIT) cover its interest expense (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).

International Conglomerate of Distribution for Automobile Holdings's net debt is only 0.94 times its EBITDA. And its EBIT covers its interest expense a whopping 359 times over. So you could argue it is no more threatened by its debt than an elephant is by a mouse. On top of that, International Conglomerate of Distribution for Automobile Holdings grew its EBIT by 31% over the last twelve months, and that growth will make it easier to handle 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 International Conglomerate of Distribution for Automobile Holdings 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 we always check how much of that EBIT is translated into free cash flow. Considering the last three years, International Conglomerate of Distribution for Automobile Holdings actually recorded a cash outflow, overall. Debt is far more risky for companies with unreliable free cash flow, so shareholders should be hoping that the past expenditure will produce free cash flow in the future.

Our View

On the face of it, International Conglomerate of Distribution for Automobile Holdings's conversion of EBIT to free cash flow left us tentative about the stock, and its level of total liabilities was no more enticing than the one empty restaurant on the busiest night of the year. But on the bright side, its interest cover is a good sign, and makes us more optimistic. Once we consider all the factors above, together, it seems to us that International Conglomerate of Distribution for Automobile Holdings's debt is making it a bit risky. Some people like that sort of risk, but we're mindful of the potential pitfalls, so we'd probably prefer it carry less debt. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. For instance, we've identified 4 warning signs for International Conglomerate of Distribution for Automobile Holdings (1 is concerning) you should be aware of.

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. 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.

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