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.' So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. As with many other companies SOLXYZ Co., Ltd. (TSE:4284) makes use of debt. But should shareholders be worried about its use of debt?
Why Does Debt Bring Risk?
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 usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. 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 SOLXYZ
How Much Debt Does SOLXYZ Carry?
You can click the graphic below for the historical numbers, but it shows that SOLXYZ had JP¥930.0m of debt in March 2024, down from JP¥1.05b, one year before. However, its balance sheet shows it holds JP¥4.60b in cash, so it actually has JP¥3.67b net cash.
A Look At SOLXYZ's Liabilities
Zooming in on the latest balance sheet data, we can see that SOLXYZ had liabilities of JP¥3.09b due within 12 months and liabilities of JP¥779.0m due beyond that. On the other hand, it had cash of JP¥4.60b and JP¥2.64b worth of receivables due within a year. So it can boast JP¥3.37b more liquid assets than total liabilities.
This excess liquidity is a great indication that SOLXYZ's balance sheet is almost as strong as Fort Knox. Having regard to this fact, we think its balance sheet is as strong as an ox. Succinctly put, SOLXYZ boasts net cash, so it's fair to say it does not have a heavy debt load!
But the bad news is that SOLXYZ has seen its EBIT plunge 11% in the last twelve months. We think hat kind of performance, if repeated frequently, could well lead to difficulties for the stock. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since SOLXYZ 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 company can only pay off debt with cold hard cash, not accounting profits. SOLXYZ 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, SOLXYZ produced sturdy free cash flow equating to 60% of its EBIT, about what we'd expect. This cold hard cash means it can reduce its debt when it wants to.
Summing Up
While we empathize with investors who find debt concerning, you should keep in mind that SOLXYZ has net cash of JP¥3.67b, as well as more liquid assets than liabilities. So we don't think SOLXYZ'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. Case in point: We've spotted 2 warning signs for SOLXYZ you should be aware of.
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:4284
Flawless balance sheet 6 star dividend payer.
