Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' 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 SYS Holdings Co., Ltd. (TYO:3988) does use debt in its business. But the more important question is: how much risk is that debt creating?
When Is Debt Dangerous?
Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. 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.
See our latest analysis for SYS Holdings
What Is SYS Holdings's Debt?
As you can see below, at the end of October 2020, SYS Holdings had JP¥530.0m of debt, up from JP¥277.0m a year ago. Click the image for more detail. However, it does have JP¥2.37b in cash offsetting this, leading to net cash of JP¥1.84b.
A Look At SYS Holdings' Liabilities
According to the last reported balance sheet, SYS Holdings had liabilities of JP¥1.26b due within 12 months, and liabilities of JP¥361.0m due beyond 12 months. Offsetting this, it had JP¥2.37b in cash and JP¥581.0m in receivables that were due within 12 months. So it can boast JP¥1.33b more liquid assets than total liabilities.
This surplus liquidity suggests that SYS Holdings' balance sheet could take a hit just as well as Homer Simpson's head can take a punch. On this view, lenders should feel as safe as the beloved of a black-belt karate master. Simply put, the fact that SYS Holdings has more cash than debt is arguably a good indication that it can manage its debt safely.
Also good is that SYS Holdings grew its EBIT at 12% over the last year, further increasing its ability to manage debt. There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since SYS Holdings 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.
Finally, a company can only pay off debt with cold hard cash, not accounting profits. 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. During the last three years, SYS Holdings generated free cash flow amounting to a very robust 81% of its EBIT, more than we'd expect. That puts it in a very strong position to pay down debt.
Summing up
While we empathize with investors who find debt concerning, you should keep in mind that SYS Holdings has net cash of JP¥1.84b, as well as more liquid assets than liabilities. The cherry on top was that in converted 81% of that EBIT to free cash flow, bringing in JP¥355m. So we don't think SYS Holdings's use of debt is risky. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. Take risks, for example - SYS Holdings has 1 warning sign we think you should be aware of.
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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About TSE:3988
SYS Holdings
Provides information technology services in Japan and internationally.
Solid track record with excellent balance sheet.
