New Cosmos ElectricLtd (TYO:6824) Seems To Use Debt Rather Sparingly

Warren Buffett famously said, 'Volatility is far from synonymous with risk.' 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 New Cosmos Electric Co.,Ltd. (TYO:6824) does use debt in its business. But the more important question is: how much risk is that debt creating?

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 usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. 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.

Check out our latest analysis for New Cosmos ElectricLtd

How Much Debt Does New Cosmos ElectricLtd Carry?

The chart below, which you can click on for greater detail, shows that New Cosmos ElectricLtd had JP¥1.77b in debt in December 2020; about the same as the year before. But on the other hand it also has JP¥13.2b in cash, leading to a JP¥11.4b net cash position.

How Healthy Is New Cosmos ElectricLtd's Balance Sheet?

According to the last reported balance sheet, New Cosmos ElectricLtd had liabilities of JP¥6.57b due within 12 months, and liabilities of JP¥2.90b due beyond 12 months. Offsetting these obligations, it had cash of JP¥13.2b as well as receivables valued at JP¥7.75b due within 12 months. So it can boast JP¥11.5b more liquid assets than total liabilities.

This excess liquidity is a great indication that New Cosmos ElectricLtd's balance sheet is almost as strong as Fort Knox. 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 top of that, New Cosmos ElectricLtd grew its EBIT by 53% over the last twelve months, and that growth will make it easier to handle its debt. 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. While New Cosmos ElectricLtd 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 most recent three years, New Cosmos ElectricLtd recorded free cash flow worth 53% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This free cash flow puts the company in a good position to pay down debt, when appropriate.

Summing up

While we empathize with investors who find debt concerning, you should keep in mind that New Cosmos ElectricLtd has net cash of JP¥11.4b, as well as more liquid assets than liabilities. And it impressed us with its EBIT growth of 53% over the last year. So we don't think New Cosmos ElectricLtd'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. For example - New Cosmos ElectricLtd has 1 warning sign we think you should be aware of.

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.

If you’re looking to trade New Cosmos ElectricLtd, open an account with the lowest-cost* platform trusted by professionals, Interactive Brokers. Their clients from over 200 countries and territories trade stocks, options, futures, forex, bonds and funds worldwide from a single integrated account. Promoted

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.
^*Interactive Brokers Rated Lowest Cost Broker by StockBrokers.com Annual Online Review 2020

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