Is Tamagawa Holdings (TYO:6838) Using Too Much Debt?

Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk.' So it seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. As with many other companies Tamagawa Holdings Co., Ltd. (TYO:6838) makes use of debt. But should shareholders be worried about its use of debt?

When Is Debt Dangerous?

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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

View our latest analysis for Tamagawa Holdings

What Is Tamagawa Holdings's Net Debt?

As you can see below, at the end of September 2020, Tamagawa Holdings had JP¥876.0m of debt, up from JP¥814.0m a year ago. Click the image for more detail. However, it does have JP¥2.03b in cash offsetting this, leading to net cash of JP¥1.15b.

A Look At Tamagawa Holdings' Liabilities

Zooming in on the latest balance sheet data, we can see that Tamagawa Holdings had liabilities of JP¥1.74b due within 12 months and liabilities of JP¥3.33b due beyond that. On the other hand, it had cash of JP¥2.03b and JP¥1.57b worth of receivables due within a year. So its liabilities total JP¥1.47b more than the combination of its cash and short-term receivables.

Of course, Tamagawa Holdings has a market capitalization of JP¥12.0b, so these liabilities are probably manageable. Having said that, it's clear that we should continue to monitor its balance sheet, lest it change for the worse. Despite its noteworthy liabilities, Tamagawa Holdings boasts net cash, so it's fair to say it does not have a heavy debt load!

One way Tamagawa Holdings could vanquish its debt would be if it stops borrowing more but continues to grow EBIT at around 13%, as it did over the last year. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since Tamagawa Holdings 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.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. Tamagawa Holdings 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, Tamagawa Holdings produced sturdy free cash flow equating to 68% of its EBIT, about what we'd expect. This free cash flow puts the company in a good position to pay down debt, when appropriate.

Summing up

While Tamagawa Holdings does have more liabilities than liquid assets, it also has net cash of JP¥1.15b. And it impressed us with free cash flow of JP¥1.0b, being 68% of its EBIT. So we are not troubled with Tamagawa Holdings's debt use. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. We've identified 2 warning signs with Tamagawa Holdings , and understanding them should be part of your investment process.

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

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