Is SCSK (TSE:9719) Using Too Much 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 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 SCSK Corporation (TSE:9719) makes use of debt. But the more important question is: how much risk is that debt creating?

When Is Debt Dangerous?

Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. 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. 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. When we examine debt levels, we first consider both cash and debt levels, together.

View our latest analysis for SCSK

What Is SCSK's Debt?

The chart below, which you can click on for greater detail, shows that SCSK had JP¥30.2b in debt in September 2024; about the same as the year before. But it also has JP¥150.3b in cash to offset that, meaning it has JP¥120.1b net cash.

How Strong Is SCSK's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that SCSK had liabilities of JP¥99.4b due within 12 months and liabilities of JP¥71.9b due beyond that. Offsetting this, it had JP¥150.3b in cash and JP¥71.3b in receivables that were due within 12 months. So it can boast JP¥50.2b more liquid assets than total liabilities.

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

The good news is that SCSK has increased its EBIT by 2.4% over twelve months, which should ease any concerns about debt repayment. The balance sheet is clearly the area to focus on when you are analysing debt. But it is future earnings, more than anything, that will determine SCSK'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. SCSK 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, SCSK generated free cash flow amounting to a very robust 80% of its EBIT, more than we'd expect. That puts it in a very strong position to pay down debt.

Summing Up

While it is always sensible to investigate a company's debt, in this case SCSK has JP¥120.1b in net cash and a decent-looking balance sheet. The cherry on top was that in converted 80% of that EBIT to free cash flow, bringing in JP¥46b. So is SCSK's debt a risk? It doesn't seem so to us. Over time, share prices tend to follow earnings per share, so if you're interested in SCSK, you may well want to click here to check an interactive graph of its earnings per share history.

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.