Estore (TYO:4304) Seems To Use Debt Rather Sparingly

Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' 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. Importantly, Estore Corporation (TYO:4304) does carry debt. But should shareholders be worried about its use of debt?

Why Does Debt Bring Risk?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. If things get really bad, the lenders can take control of the business. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we think about a company's use of debt, we first look at cash and debt together.

View our latest analysis for Estore

How Much Debt Does Estore Carry?

The image below, which you can click on for greater detail, shows that at September 2020 Estore had debt of JP¥1.90b, up from JP¥999.0m in one year. But on the other hand it also has JP¥3.37b in cash, leading to a JP¥1.47b net cash position.

A Look At Estore's Liabilities

Zooming in on the latest balance sheet data, we can see that Estore had liabilities of JP¥3.61b due within 12 months and liabilities of JP¥1.98b due beyond that. Offsetting these obligations, it had cash of JP¥3.37b as well as receivables valued at JP¥1.16b due within 12 months. So its liabilities total JP¥1.07b more than the combination of its cash and short-term receivables.

Of course, Estore has a market capitalization of JP¥11.6b, so these liabilities are probably manageable. But there are sufficient liabilities that we would certainly recommend shareholders continue to monitor the balance sheet, going forward. While it does have liabilities worth noting, Estore also has more cash than debt, so we're pretty confident it can manage its debt safely.

In addition to that, we're happy to report that Estore has boosted its EBIT by 32%, thus reducing the spectre of future debt repayments. The balance sheet is clearly the area to focus on when you are analysing debt. But you can't view debt in total isolation; since Estore 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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. Estore 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. Over the most recent three years, Estore recorded free cash flow worth 71% 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

We could understand if investors are concerned about Estore's liabilities, but we can be reassured by the fact it has has net cash of JP¥1.47b. And we liked the look of last year's 32% year-on-year EBIT growth. So is Estore's debt a risk? It doesn't seem so to us. 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. For instance, we've identified 2 warning signs for Estore that you should be aware of.

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

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