Does Showa Shinku (TYO:6384) Have A Healthy Balance Sheet?

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 Showa Shinku Co., Ltd. (TYO:6384) 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 is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. If things get really bad, the lenders can take control of the business. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we examine debt levels, we first consider both cash and debt levels, together.

See our latest analysis for Showa Shinku

What Is Showa Shinku's Net Debt?

As you can see below, Showa Shinku had JP¥549.0m of debt, at September 2020, which is about the same as the year before. You can click the chart for greater detail. However, its balance sheet shows it holds JP¥3.33b in cash, so it actually has JP¥2.78b net cash.

How Strong Is Showa Shinku's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Showa Shinku had liabilities of JP¥4.36b due within 12 months and liabilities of JP¥358.0m due beyond that. On the other hand, it had cash of JP¥3.33b and JP¥3.25b worth of receivables due within a year. So it can boast JP¥1.86b more liquid assets than total liabilities.

This excess liquidity suggests that Showa Shinku is taking a careful approach to debt. Given it has easily adequate short term liquidity, we don't think it will have any issues with its lenders. Succinctly put, Showa Shinku boasts net cash, so it's fair to say it does not have a heavy debt load!

On top of that, Showa Shinku grew its EBIT by 46% over the last twelve months, and that growth will make it easier to handle its debt. There's no doubt that we learn most about debt from the balance sheet. But it is Showa Shinku's earnings that will influence how the balance sheet holds up in the future. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. Showa Shinku 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, Showa Shinku produced sturdy free cash flow equating to 61% 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 Showa Shinku has net cash of JP¥2.78b, as well as more liquid assets than liabilities. And it impressed us with its EBIT growth of 46% over the last year. So we don't think Showa Shinku'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. Consider for instance, the ever-present spectre of investment risk. We've identified 3 warning signs with Showa Shinku (at least 1 which makes us a bit uncomfortable) , and understanding them should be part of your investment process.

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. 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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