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.' 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 can see that Rakus Co., Ltd. (TSE:3923) does use debt in its business. But should shareholders be worried about its use of debt?
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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.
See our latest analysis for Rakus
How Much Debt Does Rakus Carry?
The image below, which you can click on for greater detail, shows that at March 2024 Rakus had debt of JPĀ„970.0m, up from JPĀ„36.0m in one year. However, it does have JPĀ„7.01b in cash offsetting this, leading to net cash of JPĀ„6.04b.
How Strong Is Rakus' Balance Sheet?
Zooming in on the latest balance sheet data, we can see that Rakus had liabilities of JPĀ„7.37b due within 12 months and liabilities of JPĀ„515.0m due beyond that. Offsetting this, it had JPĀ„7.01b in cash and JPĀ„5.68b in receivables that were due within 12 months. So it can boast JPĀ„4.81b more liquid assets than total liabilities.
Having regard to Rakus' size, it seems that its liquid assets are well balanced with its total liabilities. So it's very unlikely that the JPĀ„407.6b company is short on cash, but still worth keeping an eye on the balance sheet. Succinctly put, Rakus boasts net cash, so it's fair to say it does not have a heavy debt load!
Even more impressive was the fact that Rakus grew its EBIT by 240% over twelve months. If maintained that growth will make the debt even more manageable in the years ahead. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Rakus's ability to maintain a healthy balance sheet going forward. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.
Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. Rakus 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. During the last three years, Rakus produced sturdy free cash flow equating to 63% of its EBIT, about what we'd expect. This free cash flow puts the company in a good position to pay down debt, when appropriate.
Summing Up
While it is always sensible to investigate a company's debt, in this case Rakus has JPĀ„6.04b in net cash and a decent-looking balance sheet. And we liked the look of last year's 240% year-on-year EBIT growth. So we don't think Rakus's use of debt is 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. These risks can be hard to spot. Every company has them, and we've spotted 1 warning sign for Rakus you should know about.
At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.
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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.
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About TSE:3923
Outstanding track record with high growth potential.
