Kyoritsu Electric (TYO:6874) Could Easily Take On More Debt

Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' 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. Importantly, Kyoritsu Electric Corporation (TYO:6874) does carry debt. 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. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. The first step when considering a company's debt levels is to consider its cash and debt together.

View our latest analysis for Kyoritsu Electric

What Is Kyoritsu Electric's Debt?

The chart below, which you can click on for greater detail, shows that Kyoritsu Electric had JP¥1.70b in debt in September 2020; about the same as the year before. However, it does have JP¥4.68b in cash offsetting this, leading to net cash of JP¥2.98b.

How Strong Is Kyoritsu Electric's Balance Sheet?

According to the last reported balance sheet, Kyoritsu Electric had liabilities of JP¥7.26b due within 12 months, and liabilities of JP¥2.20b due beyond 12 months. On the other hand, it had cash of JP¥4.68b and JP¥8.93b worth of receivables due within a year. So it can boast JP¥4.15b more liquid assets than total liabilities.

This surplus strongly suggests that Kyoritsu Electric has a rock-solid balance sheet (and the debt is of no concern whatsoever). On this basis we think its balance sheet is strong like a sleek panther or even a proud lion. Simply put, the fact that Kyoritsu Electric has more cash than debt is arguably a good indication that it can manage its debt safely.

On the other hand, Kyoritsu Electric's EBIT dived 18%, over the last year. We think hat kind of performance, if repeated frequently, could well lead to difficulties for the stock. There's no doubt that we learn most about debt from the balance sheet. But it is Kyoritsu Electric'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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. While Kyoritsu Electric 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. During the last three years, Kyoritsu Electric produced sturdy free cash flow equating to 71% 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 it is always sensible to investigate a company's debt, in this case Kyoritsu Electric has JP¥2.98b in net cash and a decent-looking balance sheet. And it impressed us with free cash flow of JP¥2.1b, being 71% of its EBIT. So we don't think Kyoritsu Electric's use of debt is risky. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. To that end, you should be aware of the 1 warning sign we've spotted with Kyoritsu Electric .

When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.

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