Here's Why Tokyo Seimitsu (TSE:7729) Can Manage Its Debt Responsibly

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 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 Tokyo Seimitsu Co., Ltd. (TSE:7729) makes use of debt. But is this debt a concern to shareholders?

When Is Debt Dangerous?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. 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. Of course, plenty of companies use debt to fund growth, without any negative consequences. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

View our latest analysis for Tokyo Seimitsu

How Much Debt Does Tokyo Seimitsu Carry?

You can click the graphic below for the historical numbers, but it shows that as of March 2024 Tokyo Seimitsu had JP¥24.3b of debt, an increase on JP¥13.3b, over one year. But on the other hand it also has JP¥36.8b in cash, leading to a JP¥12.5b net cash position.

A Look At Tokyo Seimitsu's Liabilities

The latest balance sheet data shows that Tokyo Seimitsu had liabilities of JP¥46.0b due within a year, and liabilities of JP¥21.1b falling due after that. Offsetting this, it had JP¥36.8b in cash and JP¥42.8b in receivables that were due within 12 months. So it can boast JP¥12.4b more liquid assets than total liabilities.

This surplus suggests that Tokyo Seimitsu has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Simply put, the fact that Tokyo Seimitsu has more cash than debt is arguably a good indication that it can manage its debt safely.

The modesty of its debt load may become crucial for Tokyo Seimitsu if management cannot prevent a repeat of the 27% 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 it is future earnings, more than anything, that will determine Tokyo Seimitsu's ability to maintain a healthy balance sheet going forward. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. Tokyo Seimitsu 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, Tokyo Seimitsu barely recorded positive free cash flow, in total. While many companies do operate at break-even, we prefer see substantial free cash flow, especially if a it already has dead.

Summing Up

While it is always sensible to investigate a company's debt, in this case Tokyo Seimitsu has JP¥12.5b in net cash and a decent-looking balance sheet. So we don't have any problem with Tokyo Seimitsu's use of debt. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. We've identified 2 warning signs with Tokyo Seimitsu , and understanding them should be part of your investment process.

When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.

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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.