Here's Why SAKURA Internet (TSE:3778) Can Manage Its Debt Responsibly

The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' 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 can see that SAKURA Internet Inc. (TSE:3778) does use debt in its business. But the real question is whether this debt is making the company risky.

When Is Debt A Problem?

Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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. When we think about a company's use of debt, we first look at cash and debt together.

See our latest analysis for SAKURA Internet

What Is SAKURA Internet's Net Debt?

You can click the graphic below for the historical numbers, but it shows that as of June 2024 SAKURA Internet had JP¥8.68b of debt, an increase on JP¥3.75b, over one year. However, its balance sheet shows it holds JP¥23.3b in cash, so it actually has JP¥14.6b net cash.

How Healthy Is SAKURA Internet's Balance Sheet?

According to the last reported balance sheet, SAKURA Internet had liabilities of JP¥11.1b due within 12 months, and liabilities of JP¥14.0b due beyond 12 months. Offsetting these obligations, it had cash of JP¥23.3b as well as receivables valued at JP¥2.41b due within 12 months. So it can boast JP¥518.9m more liquid assets than total liabilities.

This state of affairs indicates that SAKURA Internet's balance sheet looks quite solid, as its total liabilities are just about equal to its liquid assets. So it's very unlikely that the JP¥165.5b company is short on cash, but still worth keeping an eye on the balance sheet. Simply put, the fact that SAKURA Internet has more cash than debt is arguably a good indication that it can manage its debt safely.

We saw SAKURA Internet grow its EBIT by 6.2% in the last twelve months. Whilst that hardly knocks our socks off it is a positive when it comes to debt. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since SAKURA Internet 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.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. SAKURA Internet 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. Happily for any shareholders, SAKURA Internet actually produced more free cash flow than EBIT over the last three years. That sort of strong cash conversion gets us as excited as the crowd when the beat drops at a Daft Punk concert.

Summing Up

While we empathize with investors who find debt concerning, you should keep in mind that SAKURA Internet has net cash of JP¥14.6b, as well as more liquid assets than liabilities. And it impressed us with free cash flow of -JP¥734m, being 166% of its EBIT. So is SAKURA Internet'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 SAKURA Internet (1 is significant) 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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. 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.