Here's Why Shibaura ElectronicsLtd (TYO:6957) Can Manage Its Debt Responsibly

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 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. As with many other companies Shibaura Electronics Co.,Ltd. (TYO:6957) makes use of debt. But the more important question is: how much risk is that debt creating?

What Risk Does Debt Bring?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. If things get really bad, the lenders can take control of the business. 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. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. 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 Shibaura ElectronicsLtd

How Much Debt Does Shibaura ElectronicsLtd Carry?

The image below, which you can click on for greater detail, shows that at September 2020 Shibaura ElectronicsLtd had debt of JP¥5.39b, up from JP¥3.25b in one year. However, its balance sheet shows it holds JP¥10.1b in cash, so it actually has JP¥4.70b net cash.

How Healthy Is Shibaura ElectronicsLtd's Balance Sheet?

We can see from the most recent balance sheet that Shibaura ElectronicsLtd had liabilities of JP¥6.62b falling due within a year, and liabilities of JP¥4.24b due beyond that. Offsetting this, it had JP¥10.1b in cash and JP¥5.85b in receivables that were due within 12 months. So it can boast JP¥5.08b more liquid assets than total liabilities.

This excess liquidity suggests that Shibaura ElectronicsLtd is taking a careful approach to debt. Because it has plenty of assets, it is unlikely to have trouble with its lenders. Succinctly put, Shibaura ElectronicsLtd boasts net cash, so it's fair to say it does not have a heavy debt load!

On the other hand, Shibaura ElectronicsLtd's EBIT dived 13%, over the last year. If that rate of decline in earnings continues, the company could find itself in a tight spot. The balance sheet is clearly the area to focus on when you are analysing debt. But it is future earnings, more than anything, that will determine Shibaura ElectronicsLtd's ability to maintain a healthy balance sheet going forward. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. While Shibaura ElectronicsLtd 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. In the last three years, Shibaura ElectronicsLtd's free cash flow amounted to 25% of its EBIT, less than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.

Summing up

While we empathize with investors who find debt concerning, you should keep in mind that Shibaura ElectronicsLtd has net cash of JP¥4.70b, as well as more liquid assets than liabilities. So we don't have any problem with Shibaura ElectronicsLtd's use of debt. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. Consider for instance, the ever-present spectre of investment risk. We've identified 2 warning signs with Shibaura ElectronicsLtd , and understanding them should be part of your investment process.

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

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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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