Advantest (TSE:6857) Seems To Use Debt Rather Sparingly

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. We note that Advantest Corporation (TSE:6857) does have debt on its balance sheet. But is this debt a concern to shareholders?

Why Does Debt Bring Risk?

Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own 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. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. When we examine debt levels, we first consider both cash and debt levels, together.

View our latest analysis for Advantest

How Much Debt Does Advantest Carry?

As you can see below, Advantest had JP¥75.8b of debt, at December 2024, which is about the same as the year before. You can click the chart for greater detail. But it also has JP¥196.0b in cash to offset that, meaning it has JP¥120.2b net cash.

How Strong Is Advantest's Balance Sheet?

The latest balance sheet data shows that Advantest had liabilities of JP¥183.2b due within a year, and liabilities of JP¥113.7b falling due after that. Offsetting these obligations, it had cash of JP¥196.0b as well as receivables valued at JP¥111.6b due within 12 months. So it can boast JP¥10.7b more liquid assets than total liabilities.

Having regard to Advantest's size, it seems that its liquid assets are well balanced with its total liabilities. So while it's hard to imagine that the JP¥5.74t company is struggling for cash, we still think it's worth monitoring its balance sheet. Simply put, the fact that Advantest has more cash than debt is arguably a good indication that it can manage its debt safely.

In addition to that, we're happy to report that Advantest has boosted its EBIT by 88%, thus reducing the spectre of future debt repayments. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Advantest can strengthen its balance sheet over time. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. While Advantest has net cash on its balance sheet, it's still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. During the last three years, Advantest produced sturdy free cash flow equating to 52% of its EBIT, about what we'd expect. This cold hard cash means it can reduce its debt when it wants to.

Summing Up

While we empathize with investors who find debt concerning, you should keep in mind that Advantest has net cash of JP¥120.2b, as well as more liquid assets than liabilities. And we liked the look of last year's 88% year-on-year EBIT growth. So is Advantest's debt a risk? It doesn't seem so to us. 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. Be aware that Advantest is showing 1 warning sign in our investment analysis , you should know about...

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.