Is Advantest (TSE:6857) Using Too Much 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.' 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. As with many other companies Advantest Corporation (TSE:6857) makes use of debt. But the more important question is: how much risk is that debt creating?

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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, debt can be an important tool in businesses, particularly capital heavy businesses. The first step when considering a company's debt levels is to consider its cash and debt together.

View our latest analysis for Advantest

What Is Advantest's Net Debt?

You can click the graphic below for the historical numbers, but it shows that as of September 2024 Advantest had JP¥74.3b of debt, an increase on JP¥55.0b, over one year. However, its balance sheet shows it holds JP¥167.2b in cash, so it actually has JP¥92.9b net cash.

How Healthy Is Advantest's Balance Sheet?

The latest balance sheet data shows that Advantest had liabilities of JP¥174.3b due within a year, and liabilities of JP¥112.0b falling due after that. On the other hand, it had cash of JP¥167.2b and JP¥114.1b worth of receivables due within a year. So these liquid assets roughly match the total liabilities.

This state of affairs indicates that Advantest's balance sheet looks quite solid, as its total liabilities are just about equal to its liquid assets. So while it's hard to imagine that the JP¥6.09t company is struggling for cash, we still think it's worth monitoring its balance sheet. Despite its noteworthy liabilities, Advantest boasts net cash, so it's fair to say it does not have a heavy debt load!

Also positive, Advantest grew its EBIT by 29% in the last year, and that should make it easier to pay down debt, going forward. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Advantest's ability to maintain a healthy balance sheet going forward. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. Advantest 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. Looking at the most recent three years, Advantest recorded free cash flow of 42% of its EBIT, which is weaker than we'd expect. That's not great, when it comes to paying down debt.

Summing Up

We could understand if investors are concerned about Advantest's liabilities, but we can be reassured by the fact it has has net cash of JP¥92.9b. And we liked the look of last year's 29% year-on-year EBIT growth. So we don't think Advantest's use of debt is risky. 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 example, we've discovered 1 warning sign for Advantest that you should be aware of before investing here.

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

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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.