airCloset (TSE:9557) Has A Somewhat Strained Balance Sheet

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.' 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. Importantly, airCloset, Inc. (TSE:9557) does carry debt. But is this debt a concern to shareholders?

Why Does Debt Bring Risk?

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. 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. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. When we examine debt levels, we first consider both cash and debt levels, together.

View our latest analysis for airCloset

How Much Debt Does airCloset Carry?

As you can see below, at the end of September 2024, airCloset had JP¥1.42b of debt, up from JP¥1.36b a year ago. Click the image for more detail. However, because it has a cash reserve of JP¥1.31b, its net debt is less, at about JP¥108.0m.

How Strong Is airCloset's Balance Sheet?

We can see from the most recent balance sheet that airCloset had liabilities of JP¥1.21b falling due within a year, and liabilities of JP¥987.0m due beyond that. Offsetting these obligations, it had cash of JP¥1.31b as well as receivables valued at JP¥315.0m due within 12 months. So it has liabilities totalling JP¥576.0m more than its cash and near-term receivables, combined.

Since publicly traded airCloset shares are worth a total of JP¥4.28b, it seems unlikely that this level of liabilities would be a major threat. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time.

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). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

Given net debt is only 0.17 times EBITDA, it is initially surprising to see that airCloset's EBIT has low interest coverage of 1.2 times. So while we're not necessarily alarmed we think that its debt is far from trivial. Notably, airCloset made a loss at the EBIT level, last year, but improved that to positive EBIT of JP¥23m in the last twelve months. There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since airCloset 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, while the tax-man may adore accounting profits, lenders only accept 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. Over the last year, airCloset saw substantial negative free cash flow, in total. While investors are no doubt expecting a reversal of that situation in due course, it clearly does mean its use of debt is more risky.

Our View

While airCloset's interest cover makes us cautious about it, its track record of converting EBIT to free cash flow is no better. But on the brighter side of life, its net debt to EBITDA leaves us feeling more frolicsome. Taking the abovementioned factors together we do think airCloset's debt poses some risks to the business. So while that leverage does boost returns on equity, we wouldn't really want to see it increase from here. 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 2 warning signs for airCloset that you should be aware of before investing here.

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

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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.