Datasection (TSE:3905) Is Carrying A Fair Bit Of Debt

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 can see that Datasection Inc. (TSE:3905) does use debt in its business. But the more important question is: how much risk is that debt creating?

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 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. 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 Datasection

How Much Debt Does Datasection Carry?

The chart below, which you can click on for greater detail, shows that Datasection had JP¥1.30b in debt in September 2024; about the same as the year before. However, because it has a cash reserve of JP¥1.02b, its net debt is less, at about JP¥280.0m.

A Look At Datasection's Liabilities

The latest balance sheet data shows that Datasection had liabilities of JP¥1.49b due within a year, and liabilities of JP¥449.0m falling due after that. On the other hand, it had cash of JP¥1.02b and JP¥716.0m worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by JP¥198.0m.

This state of affairs indicates that Datasection'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¥14.8b company is short on cash, but still worth keeping an eye on the balance sheet. There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since Datasection 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.

In the last year Datasection wasn't profitable at an EBIT level, but managed to grow its revenue by 28%, to JP¥2.6b. With any luck the company will be able to grow its way to profitability.

Caveat Emptor

While we can certainly appreciate Datasection's revenue growth, its earnings before interest and tax (EBIT) loss is not ideal. To be specific the EBIT loss came in at JP¥221m. When we look at that and recall the liabilities on its balance sheet, relative to cash, it seems unwise to us for the company to have any debt. So we think its balance sheet is a little strained, though not beyond repair. However, it doesn't help that it burned through JP¥580m of cash over the last year. So suffice it to say we do consider the stock to be risky. 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, we've discovered 4 warning signs for Datasection (2 are potentially serious!) that you should be aware of before investing here.

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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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.