SCSK (TSE:9719) Seems To Use Debt Rather Sparingly

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.' 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 SCSK Corporation (TSE:9719) does use debt in its business. But the real question is whether this debt is making the company risky.

What Risk Does Debt Bring?

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 common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. Of course, plenty of companies use debt to fund growth, without any negative consequences. The first step when considering a company's debt levels is to consider its cash and debt together.

See 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¥31.3b in debt in June 2024; about the same as the year before. However, its balance sheet shows it holds JP¥149.4b in cash, so it actually has JP¥118.1b net cash.

How Healthy Is SCSK's Balance Sheet?

According to the last reported balance sheet, SCSK had liabilities of JP¥96.2b due within 12 months, and liabilities of JP¥67.2b due beyond 12 months. Offsetting these obligations, it had cash of JP¥149.4b as well as receivables valued at JP¥67.7b due within 12 months. So it can boast JP¥53.7b 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 4.9% 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're focused on the future you can check out this free report showing analyst profit forecasts.

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. Over the most recent three years, SCSK recorded free cash flow worth 77% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This cold hard cash means it can reduce its debt when it wants to.

Summing Up

While it is always sensible to investigate a company's debt, in this case SCSK has JP¥118.1b in net cash and a decent-looking balance sheet. The cherry on top was that in converted 77% of that EBIT to free cash flow, bringing in JP¥49b. So we don't think SCSK's use of debt is risky. Above most other metrics, we think its important to track how fast earnings per share is growing, if at all. If you've also come to that realization, you're in luck, because today you can view this interactive graph of SCSK's earnings per share history for free.

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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

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.