Creema (TSE:4017) Could Easily Take On More Debt

The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says '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. As with many other companies Creema Ltd. (TSE:4017) makes use of debt. But is this debt a concern to shareholders?

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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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.

Check out our latest analysis for Creema

What Is Creema's Debt?

You can click the graphic below for the historical numbers, but it shows that as of February 2024 Creema had JP¥517.0m of debt, an increase on JP¥381.0m, over one year. However, its balance sheet shows it holds JP¥2.63b in cash, so it actually has JP¥2.12b net cash.

How Strong Is Creema's Balance Sheet?

According to the last reported balance sheet, Creema had liabilities of JP¥2.26b due within 12 months, and liabilities of JP¥326.0m due beyond 12 months. On the other hand, it had cash of JP¥2.63b and JP¥648.0m worth of receivables due within a year. So it actually has JP¥692.0m more liquid assets than total liabilities.

This excess liquidity suggests that Creema is taking a careful approach to debt. Due to its strong net asset position, it is not likely to face issues with its lenders. Simply put, the fact that Creema has more cash than debt is arguably a good indication that it can manage its debt safely.

Although Creema made a loss at the EBIT level, last year, it was also good to see that it generated JP¥41m in EBIT over the last twelve months. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since Creema will need earnings to service that debt. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. Creema 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 last year, Creema actually produced more free cash flow than EBIT. That sort of strong cash generation warms our hearts like a puppy in a bumblebee suit.

Summing Up

While we empathize with investors who find debt concerning, you should keep in mind that Creema has net cash of JP¥2.12b, as well as more liquid assets than liabilities. The cherry on top was that in converted 276% of that EBIT to free cash flow, bringing in JP¥113m. So we don't think Creema's use of debt is risky. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. We've identified 2 warning signs with Creema (at least 1 which is concerning) , and understanding them should be part of your investment process.

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.