BroadBand Tower (TYO:3776) Has A Pretty Healthy Balance Sheet

David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the permanent loss of capital.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. As with many other companies BroadBand Tower, Inc. (TYO:3776) makes use of debt. But should shareholders be worried about its use of debt?

When Is Debt Dangerous?

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. 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.

Check out our latest analysis for BroadBand Tower

What Is BroadBand Tower's Net Debt?

The image below, which you can click on for greater detail, shows that BroadBand Tower had debt of JP¥6.69b at the end of September 2020, a reduction from JP¥7.71b over a year. However, it also had JP¥6.14b in cash, and so its net debt is JP¥549.0m.

How Healthy Is BroadBand Tower's Balance Sheet?

We can see from the most recent balance sheet that BroadBand Tower had liabilities of JP¥4.13b falling due within a year, and liabilities of JP¥7.46b due beyond that. Offsetting these obligations, it had cash of JP¥6.14b as well as receivables valued at JP¥1.99b due within 12 months. So it has liabilities totalling JP¥3.47b more than its cash and near-term receivables, combined.

Since publicly traded BroadBand Tower shares are worth a total of JP¥22.1b, it seems unlikely that this level of liabilities would be a major threat. But there are sufficient liabilities that we would certainly recommend shareholders continue to monitor the balance sheet, going forward.

In order to size up a company's debt relative to its earnings, we calculate its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and its earnings before interest and tax (EBIT) divided by its interest expense (its interest cover). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

BroadBand Tower's net debt is only 0.35 times its EBITDA. And its EBIT easily covers its interest expense, being 17.1 times the size. So you could argue it is no more threatened by its debt than an elephant is by a mouse. It was also good to see that despite losing money on the EBIT line last year, BroadBand Tower turned things around in the last 12 months, delivering and EBIT of JP¥411m. 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 BroadBand Tower 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. So it's worth checking how much of the earnings before interest and tax (EBIT) is backed by free cash flow. During the last year, BroadBand Tower burned a lot of cash. While that may be a result of expenditure for growth, it does make the debt far more risky.

Our View

Based on what we've seen BroadBand Tower is not finding it easy, given its conversion of EBIT to free cash flow, but the other factors we considered give us cause to be optimistic. In particular, we are dazzled with its interest cover. When we consider all the factors mentioned above, we do feel a bit cautious about BroadBand Tower's use of debt. While we appreciate debt can enhance returns on equity, we'd suggest that shareholders keep close watch on its debt levels, lest they increase. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. Case in point: We've spotted 3 warning signs for BroadBand Tower you should be aware of, and 2 of them don't sit too well with us.

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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