Here's Why T-Gaia (TSE:3738) Can Manage Its Debt Responsibly

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.' 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. We can see that T-Gaia Corporation (TSE:3738) does use debt in its business. 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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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 think about a company's use of debt, we first look at cash and debt together.

View our latest analysis for T-Gaia

What Is T-Gaia's Debt?

As you can see below, T-Gaia had JP¥1.88b of debt at March 2024, down from JP¥5.62b a year prior. But on the other hand it also has JP¥45.0b in cash, leading to a JP¥43.1b net cash position.

How Strong Is T-Gaia's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that T-Gaia had liabilities of JP¥167.5b due within 12 months and liabilities of JP¥3.41b due beyond that. Offsetting these obligations, it had cash of JP¥45.0b as well as receivables valued at JP¥54.5b due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by JP¥71.3b.

This deficit is considerable relative to its market capitalization of JP¥113.0b, so it does suggest shareholders should keep an eye on T-Gaia's use of debt. Should its lenders demand that it shore up the balance sheet, shareholders would likely face severe dilution. Despite its noteworthy liabilities, T-Gaia boasts net cash, so it's fair to say it does not have a heavy debt load!

And we also note warmly that T-Gaia grew its EBIT by 15% last year, making its debt load easier to handle. There's no doubt that we learn most about debt from the balance sheet. But it is future earnings, more than anything, that will determine T-Gaia's ability to maintain a healthy balance sheet going forward. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. T-Gaia may have net cash on the balance sheet, but it is still interesting to look at how well the business converts its earnings before interest and tax (EBIT) to free cash flow, because that will influence both its need for, and its capacity to manage debt. Over the most recent three years, T-Gaia recorded free cash flow worth 71% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This free cash flow puts the company in a good position to pay down debt, when appropriate.

Summing Up

While T-Gaia does have more liabilities than liquid assets, it also has net cash of JP¥43.1b. The cherry on top was that in converted 71% of that EBIT to free cash flow, bringing in -JP¥5.1b. So we don't have any problem with T-Gaia's use of debt. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. For example, we've discovered 1 warning sign for T-Gaia that you should be aware of before investing here.

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

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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.