Crops (TSE:9428) Seems To Use Debt Quite Sensibly

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 seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. Importantly, Crops Corporation (TSE:9428) does carry debt. But should shareholders be worried about its use of debt?

What Risk Does Debt Bring?

Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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, 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.

See our latest analysis for Crops

How Much Debt Does Crops Carry?

The image below, which you can click on for greater detail, shows that Crops had debt of JP¥2.79b at the end of September 2024, a reduction from JP¥3.04b over a year. But on the other hand it also has JP¥8.08b in cash, leading to a JP¥5.29b net cash position.

A Look At Crops' Liabilities

According to the last reported balance sheet, Crops had liabilities of JP¥11.6b due within 12 months, and liabilities of JP¥9.34b due beyond 12 months. On the other hand, it had cash of JP¥8.08b and JP¥5.36b worth of receivables due within a year. So it has liabilities totalling JP¥7.50b more than its cash and near-term receivables, combined.

This deficit is considerable relative to its market capitalization of JP¥10.0b, so it does suggest shareholders should keep an eye on Crops' use of debt. Should its lenders demand that it shore up the balance sheet, shareholders would likely face severe dilution. While it does have liabilities worth noting, Crops also has more cash than debt, so we're pretty confident it can manage its debt safely.

But the bad news is that Crops has seen its EBIT plunge 13% in the last twelve months. We think hat kind of performance, if repeated frequently, could well lead to difficulties for the stock. There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since Crops 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. Crops 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, Crops recorded free cash flow worth 67% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This cold hard cash means it can reduce its debt when it wants to.

Summing Up

Although Crops's balance sheet isn't particularly strong, due to the total liabilities, it is clearly positive to see that it has net cash of JP¥5.29b. And it impressed us with free cash flow of JP¥859m, being 67% of its EBIT. So we are not troubled with Crops's debt use. 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. We've identified 3 warning signs with Crops , and understanding them should be part of your investment process.

If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.

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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.