Is LAC (TYO:3857) Using Too Much Debt?

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.' 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. We note that LAC Co., Ltd. (TYO:3857) does have debt on its balance sheet. But should shareholders be worried about its use of debt?

When Is Debt Dangerous?

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. If things get really bad, the lenders can take control of the business. 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, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. When we examine debt levels, we first consider both cash and debt levels, together.

See our latest analysis for LAC

What Is LAC's Net Debt?

The image below, which you can click on for greater detail, shows that at September 2020 LAC had debt of JP¥4.94b, up from JP¥2.63b in one year. However, its balance sheet shows it holds JP¥6.08b in cash, so it actually has JP¥1.15b net cash.

How Strong Is LAC's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that LAC had liabilities of JP¥12.3b due within 12 months and liabilities of JP¥553.0m due beyond that. Offsetting these obligations, it had cash of JP¥6.08b as well as receivables valued at JP¥5.26b due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by JP¥1.48b.

Given LAC has a market capitalization of JP¥25.5b, it's hard to believe these liabilities pose much threat. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time. While it does have liabilities worth noting, LAC also has more cash than debt, so we're pretty confident it can manage its debt safely.

But the other side of the story is that LAC saw its EBIT decline by 7.1% over the last year. That sort of decline, if sustained, will obviously make debt harder to handle. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if LAC 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. LAC 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. In the last three years, LAC created free cash flow amounting to 5.3% of its EBIT, an uninspiring performance. For us, cash conversion that low sparks a little paranoia about is ability to extinguish debt.

Summing up

While it is always sensible to look at a company's total liabilities, it is very reassuring that LAC has JP¥1.15b in net cash. So we are not troubled with LAC's debt use. 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. For example, we've discovered 2 warning signs for LAC 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. 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.
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