Is Sun (TYO:6736) Using Too Much Debt?

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. We note that Sun Corporation (TYO:6736) does have debt on its balance sheet. But the more important question is: how much risk is that debt creating?

What Risk Does Debt Bring?

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. 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. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. When we think about a company's use of debt, we first look at cash and debt together.

View our latest analysis for Sun

How Much Debt Does Sun Carry?

As you can see below, at the end of December 2020, Sun had JP¥6.77b of debt, up from JP¥4.31b a year ago. Click the image for more detail. However, it does have JP¥28.0b in cash offsetting this, leading to net cash of JP¥21.2b.

A Look At Sun's Liabilities

According to the last reported balance sheet, Sun had liabilities of JP¥24.3b due within 12 months, and liabilities of JP¥1.16b due beyond 12 months. Offsetting these obligations, it had cash of JP¥28.0b as well as receivables valued at JP¥7.45b due within 12 months. So it actually has JP¥9.98b more liquid assets than total liabilities.

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

Although Sun made a loss at the EBIT level, last year, it was also good to see that it generated JP¥353m in EBIT over the last twelve months. There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since Sun will need earnings to service that debt. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. While Sun has net cash on its balance sheet, it's still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. Over the last year, Sun actually produced more free cash flow than EBIT. That sort of strong cash generation warms our hearts like a puppy in a bumblebee suit.

Summing up

While it is always sensible to investigate a company's debt, in this case Sun has JP¥21.2b in net cash and a decent-looking balance sheet. And it impressed us with free cash flow of JP¥1.3b, being 370% of its EBIT. So is Sun's debt a risk? It doesn't seem so to us. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. For example, we've discovered 2 warning signs for Sun (1 is a bit unpleasant!) that you should be aware of before investing here.

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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