Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk.' 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 Alphax Food System Co., Ltd (TYO:3814) makes use of debt. But the real question is whether this debt is making the company risky.
When Is Debt A Problem?
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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.
Check out our latest analysis for Alphax Food System
What Is Alphax Food System's Net Debt?
The image below, which you can click on for greater detail, shows that at September 2020 Alphax Food System had debt of JP¥1.80b, up from JP¥1.03b in one year. However, because it has a cash reserve of JP¥316.0m, its net debt is less, at about JP¥1.48b.
How Strong Is Alphax Food System's Balance Sheet?
Zooming in on the latest balance sheet data, we can see that Alphax Food System had liabilities of JP¥1.09b due within 12 months and liabilities of JP¥1.05b due beyond that. Offsetting these obligations, it had cash of JP¥316.0m as well as receivables valued at JP¥304.0m due within 12 months. So it has liabilities totalling JP¥1.52b more than its cash and near-term receivables, combined.
This is a mountain of leverage relative to its market capitalization of JP¥2.25b. Should its lenders demand that it shore up the balance sheet, shareholders would likely face severe dilution. When analysing debt levels, the balance sheet is the obvious place to start. But it is Alphax Food System's earnings that will influence how the balance sheet holds up in the future. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.
In the last year Alphax Food System had a loss before interest and tax, and actually shrunk its revenue by 42%, to JP¥1.3b. That makes us nervous, to say the least.
Caveat Emptor
Not only did Alphax Food System's revenue slip over the last twelve months, but it also produced negative earnings before interest and tax (EBIT). Indeed, it lost a very considerable JP¥516m at the EBIT level. When we look at that and recall the liabilities on its balance sheet, relative to cash, it seems unwise to us for the company to have any debt. So we think its balance sheet is a little strained, though not beyond repair. However, it doesn't help that it burned through JP¥800m of cash over the last year. So suffice it to say we consider the stock very risky. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. Be aware that Alphax Food System is showing 4 warning signs in our investment analysis , and 2 of those are a bit concerning...
If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.
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About TSE:3814
Alphax Food System
Provides information systems for food service industry in Japan.
Fair value low.
