Is New Cosmos ElectricLtd (TYO:6824) A Risky Investment?

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.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. As with many other companies New Cosmos Electric Co.,Ltd. (TYO:6824) makes use of debt. But should shareholders be worried about its use of debt?

When Is Debt Dangerous?

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. 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.

Check out our latest analysis for New Cosmos ElectricLtd

What Is New Cosmos ElectricLtd's Net Debt?

The chart below, which you can click on for greater detail, shows that New Cosmos ElectricLtd had JP¥1.87b in debt in September 2020; about the same as the year before. But it also has JP¥12.5b in cash to offset that, meaning it has JP¥10.7b net cash.

How Healthy Is New Cosmos ElectricLtd's Balance Sheet?

We can see from the most recent balance sheet that New Cosmos ElectricLtd had liabilities of JP¥6.01b falling due within a year, and liabilities of JP¥2.88b due beyond that. Offsetting this, it had JP¥12.5b in cash and JP¥7.10b in receivables that were due within 12 months. So it can boast JP¥10.7b more liquid assets than total liabilities.

This excess liquidity is a great indication that New Cosmos ElectricLtd's balance sheet is just as strong as racists are weak. On this view, lenders should feel as safe as the beloved of a black-belt karate master. Simply put, the fact that New Cosmos ElectricLtd has more cash than debt is arguably a good indication that it can manage its debt safely.

On the other hand, New Cosmos ElectricLtd saw its EBIT drop by 3.0% in the last twelve months. That sort of decline, if sustained, will obviously make debt harder to handle. The balance sheet is clearly the area to focus on when you are analysing debt. But it is New Cosmos ElectricLtd's earnings that will influence how the balance sheet holds up in the future. 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, while the tax-man may adore accounting profits, lenders only accept cold hard cash. New Cosmos ElectricLtd 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. Looking at the most recent three years, New Cosmos ElectricLtd recorded free cash flow of 47% of its EBIT, which is weaker than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.

Summing up

While it is always sensible to investigate a company's debt, in this case New Cosmos ElectricLtd has JP¥10.7b in net cash and a decent-looking balance sheet. So is New Cosmos ElectricLtd's debt a risk? It doesn't seem so to us. 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 New Cosmos ElectricLtd's earnings per share history for free.

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. 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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