Does Naigai Tec (TSE:3374) Have A Healthy 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.' 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. As with many other companies Naigai Tec Corporation (TSE:3374) makes use of debt. But the real question is whether this debt is making the company risky.

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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. Of course, plenty of companies use debt to fund growth, without any negative consequences. When we think about a company's use of debt, we first look at cash and debt together.

View our latest analysis for Naigai Tec

What Is Naigai Tec's Debt?

As you can see below, Naigai Tec had JP¥4.38b of debt at March 2024, down from JP¥5.02b a year prior. However, its balance sheet shows it holds JP¥10.4b in cash, so it actually has JP¥6.00b net cash.

A Look At Naigai Tec's Liabilities

We can see from the most recent balance sheet that Naigai Tec had liabilities of JP¥11.2b falling due within a year, and liabilities of JP¥4.49b due beyond that. Offsetting these obligations, it had cash of JP¥10.4b as well as receivables valued at JP¥5.96b due within 12 months. So it actually has JP¥625.0m more liquid assets than total liabilities.

This surplus suggests that Naigai Tec has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Succinctly put, Naigai Tec boasts net cash, so it's fair to say it does not have a heavy debt load!

The modesty of its debt load may become crucial for Naigai Tec if management cannot prevent a repeat of the 48% cut to EBIT over the last year. When it comes to paying off debt, falling earnings are no more useful than sugary sodas are for your health. 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 Naigai Tec 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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. Naigai Tec 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 three years, Naigai Tec reported free cash flow worth 18% of its EBIT, which is really quite low. That limp level of cash conversion undermines its ability to manage and pay down debt.

Summing Up

While we empathize with investors who find debt concerning, you should keep in mind that Naigai Tec has net cash of JP¥6.00b, as well as more liquid assets than liabilities. So we are not troubled with Naigai Tec's debt use. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. For instance, we've identified 4 warning signs for Naigai Tec that you should be aware of.

At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.

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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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team@simplywallst.com