We Think rakumo (TSE:4060) Can Manage Its Debt With Ease

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 rakumo Inc. (TSE:4060) does use debt in its business. But is this debt a concern to shareholders?

When Is Debt A Problem?

Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. When we think about a company's use of debt, we first look at cash and debt together.

See our latest analysis for rakumo

What Is rakumo's Net Debt?

As you can see below, at the end of December 2023, rakumo had JP¥510.0m of debt, up from JP¥50.0m a year ago. Click the image for more detail. However, it does have JP¥1.89b in cash offsetting this, leading to net cash of JP¥1.38b.

A Look At rakumo's Liabilities

According to the last reported balance sheet, rakumo had liabilities of JP¥733.0m due within 12 months, and liabilities of JP¥574.0m due beyond 12 months. Offsetting this, it had JP¥1.89b in cash and JP¥49.0m in receivables that were due within 12 months. So it can boast JP¥630.0m more liquid assets than total liabilities.

This short term liquidity is a sign that rakumo could probably pay off its debt with ease, as its balance sheet is far from stretched. Succinctly put, rakumo boasts net cash, so it's fair to say it does not have a heavy debt load!

In addition to that, we're happy to report that rakumo has boosted its EBIT by 31%, thus reducing the spectre of future debt repayments. There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since rakumo will need earnings to service that debt. 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 business needs free cash flow to pay off debt; accounting profits just don't cut it. rakumo 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, rakumo generated free cash flow amounting to a very robust 99% of its EBIT, more than we'd expect. That puts it in a very strong position to pay down debt.

Summing Up

While we empathize with investors who find debt concerning, you should keep in mind that rakumo has net cash of JP¥1.38b, as well as more liquid assets than liabilities. And it impressed us with free cash flow of JP¥293m, being 99% of its EBIT. So is rakumo's debt a risk? It doesn't seem so to us. 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 - rakumo has 2 warning signs we think you should be aware of.

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

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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.