Is Ryomo SystemsLtd (TYO:9691) A Risky Investment?

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 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. We note that Ryomo Systems Co.,Ltd. (TYO:9691) does have debt on its balance sheet. 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. 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, plenty of companies use debt to fund growth, without any negative consequences. When we think about a company's use of debt, we first look at cash and debt together.

View our latest analysis for Ryomo SystemsLtd

What Is Ryomo SystemsLtd's Debt?

You can click the graphic below for the historical numbers, but it shows that Ryomo SystemsLtd had JP¥406.0m of debt in December 2020, down from JP¥1.50b, one year before. But on the other hand it also has JP¥3.61b in cash, leading to a JP¥3.21b net cash position.

A Look At Ryomo SystemsLtd's Liabilities

Zooming in on the latest balance sheet data, we can see that Ryomo SystemsLtd had liabilities of JP¥3.40b due within 12 months and liabilities of JP¥3.50b due beyond that. Offsetting this, it had JP¥3.61b in cash and JP¥4.25b in receivables that were due within 12 months. So it actually has JP¥956.0m more liquid assets than total liabilities.

This short term liquidity is a sign that Ryomo SystemsLtd could probably pay off its debt with ease, as its balance sheet is far from stretched. Simply put, the fact that Ryomo SystemsLtd has more cash than debt is arguably a good indication that it can manage its debt safely.

It is just as well that Ryomo SystemsLtd's load is not too heavy, because its EBIT was down 42% over the last year. Falling earnings (if the trend continues) could eventually make even modest debt quite risky. When analysing debt levels, the balance sheet is the obvious place to start. But it is Ryomo SystemsLtd'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.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. Ryomo SystemsLtd 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. Looking at the most recent three years, Ryomo SystemsLtd recorded free cash flow of 43% of its EBIT, which is weaker than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.

Summing up

While it is always sensible to investigate a company's debt, in this case Ryomo SystemsLtd has JP¥3.21b in net cash and a decent-looking balance sheet. So we don't have any problem with Ryomo SystemsLtd's use of debt. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. For example - Ryomo SystemsLtd has 1 warning sign we think you should be aware of.

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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