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.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. We note that Estore Corporation (TYO:4304) does have debt on its balance sheet. But the more important question is: how much risk is that debt creating?
When Is Debt A Problem?
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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. 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.
Check out our latest analysis for Estore
What Is Estore's Net Debt?
The image below, which you can click on for greater detail, shows that at December 2020 Estore had debt of JPĀ„1.97b, up from JPĀ„999.0m in one year. However, it does have JPĀ„4.87b in cash offsetting this, leading to net cash of JPĀ„2.89b.
How Strong Is Estore's Balance Sheet?
The latest balance sheet data shows that Estore had liabilities of JPĀ„4.74b due within a year, and liabilities of JPĀ„2.07b falling due after that. On the other hand, it had cash of JPĀ„4.87b and JPĀ„1.31b worth of receivables due within a year. So it has liabilities totalling JPĀ„634.0m more than its cash and near-term receivables, combined.
Since publicly traded Estore shares are worth a total of JPĀ„12.4b, it seems unlikely that this level of liabilities would be a major threat. 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 51%, thus reducing the spectre of future debt repayments. When analysing debt levels, the balance sheet is the obvious place to start. But it is Estore's earnings that will influence how the balance sheet holds up in the future. 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. While Estore 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, Estore produced sturdy free cash flow equating to 64% of its EBIT, about what we'd expect. This cold hard cash means it can reduce its debt when it wants to.
Summing up
While it is always sensible to look at a company's total liabilities, it is very reassuring that Estore has JPĀ„2.89b in net cash. And we liked the look of last year's 51% year-on-year EBIT growth. So is Estore's debt a risk? It doesn't seem so to us. 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 3 warning signs with Estore , and understanding them should be part of your investment process.
If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.
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About TSE:4304
Solid track record with adequate balance sheet.
