We Think MKSystem (TYO:3910) Can Stay On Top Of Its Debt

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 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. We can see that MKSystem Corporation (TYO:3910) does use debt in its business. 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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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, debt can be an important tool in businesses, particularly capital heavy businesses. 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 MKSystem

What Is MKSystem's Net Debt?

The chart below, which you can click on for greater detail, shows that MKSystem had JP¥554.0m in debt in December 2020; about the same as the year before. But on the other hand it also has JP¥651.0m in cash, leading to a JP¥97.0m net cash position.

How Strong Is MKSystem's Balance Sheet?

According to the last reported balance sheet, MKSystem had liabilities of JP¥538.0m due within 12 months, and liabilities of JP¥311.0m due beyond 12 months. On the other hand, it had cash of JP¥651.0m and JP¥386.0m worth of receivables due within a year. So it actually has JP¥188.0m more liquid assets than total liabilities.

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

It is just as well that MKSystem's load is not too heavy, because its EBIT was down 32% over the last year. When it comes to paying off debt, falling earnings are no more useful than sugary sodas are for your health. There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since MKSystem will need earnings to service that debt. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. While MKSystem has net cash on its balance sheet, it's still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. In the last three years, MKSystem basically broke even on a free cash flow basis. 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 MKSystem has JP¥97.0m in net cash and a decent-looking balance sheet. So we don't have any problem with MKSystem'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 4 warning signs with MKSystem (at least 1 which shouldn't be ignored) , and understanding them should be part of your investment process.

At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.

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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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