Warren Buffett famously said, 'Volatility is far from synonymous with risk.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. We note that SYS Holdings Co., Ltd. (TYO:3988) does have debt on its balance sheet. But should shareholders be worried about its use of debt?
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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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. 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.
Check out our latest analysis for SYS Holdings
What Is SYS Holdings's Debt?
You can click the graphic below for the historical numbers, but it shows that as of January 2021 SYS Holdings had JP¥505.0m of debt, an increase on JP¥260.0m, over one year. But on the other hand it also has JP¥2.26b in cash, leading to a JP¥1.75b net cash position.
How Strong Is SYS Holdings' Balance Sheet?
According to the last reported balance sheet, SYS Holdings had liabilities of JP¥1.10b due within 12 months, and liabilities of JP¥337.0m due beyond 12 months. On the other hand, it had cash of JP¥2.26b and JP¥600.0m worth of receivables due within a year. So it actually has JP¥1.42b more liquid assets than total liabilities.
This excess liquidity is a great indication that SYS Holdings' balance sheet is almost as strong as Fort Knox. With this in mind one could posit that its balance sheet means the company is able to handle some adversity. Succinctly put, SYS Holdings boasts net cash, so it's fair to say it does not have a heavy debt load!
On the other hand, SYS Holdings saw its EBIT drop by 4.0% in the last twelve months. If earnings continue to decline at that rate the company may have increasing difficulty managing its debt load. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since SYS Holdings 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 SYS Holdings 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. Over the most recent three years, SYS Holdings recorded free cash flow worth 75% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This cold hard cash means it can reduce its debt when it wants to.
Summing up
While we empathize with investors who find debt concerning, you should keep in mind that SYS Holdings has net cash of JP¥1.75b, as well as more liquid assets than liabilities. And it impressed us with free cash flow of JP¥291m, being 75% of its EBIT. So we don't think SYS Holdings's use of debt is risky. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. We've identified 1 warning sign with SYS Holdings , 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. 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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About TSE:3988
SYS Holdings
Provides information technology services in Japan and internationally.
Excellent balance sheet and good value.
