Odawara Auto-Machine Mfg (TYO:7314) 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 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. Importantly, Odawara Auto-Machine Mfg. Co., Ltd. (TYO:7314) does carry debt. But should shareholders be worried about its use of debt?

Why Does Debt Bring Risk?

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 common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. 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. When we examine debt levels, we first consider both cash and debt levels, together.

View our latest analysis for Odawara Auto-Machine Mfg

What Is Odawara Auto-Machine Mfg's Net Debt?

You can click the graphic below for the historical numbers, but it shows that Odawara Auto-Machine Mfg had JP¥542.0m of debt in December 2020, down from JP¥1.72b, one year before. However, it does have JP¥1.92b in cash offsetting this, leading to net cash of JP¥1.38b.

A Look At Odawara Auto-Machine Mfg's Liabilities

The latest balance sheet data shows that Odawara Auto-Machine Mfg had liabilities of JP¥1.46b due within a year, and liabilities of JP¥464.0m falling due after that. Offsetting these obligations, it had cash of JP¥1.92b as well as receivables valued at JP¥1.75b due within 12 months. So it can boast JP¥1.75b more liquid assets than total liabilities.

This luscious liquidity implies that Odawara Auto-Machine Mfg's balance sheet is sturdy like a giant sequoia tree. On this view, lenders should feel as safe as the beloved of a black-belt karate master. Simply put, the fact that Odawara Auto-Machine Mfg has more cash than debt is arguably a good indication that it can manage its debt safely.

In fact Odawara Auto-Machine Mfg's saving grace is its low debt levels, because its EBIT has tanked 25% in the last twelve months. When it comes to paying off debt, falling earnings are no more useful than sugary sodas are for your health. The balance sheet is clearly the area to focus on when you are analysing debt. But it is Odawara Auto-Machine Mfg'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 Odawara Auto-Machine Mfg 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 last two years, Odawara Auto-Machine Mfg actually produced more free cash flow than EBIT. There's nothing better than incoming cash when it comes to staying in your lenders' good graces.

Summing up

While it is always sensible to investigate a company's debt, in this case Odawara Auto-Machine Mfg has JP¥1.38b in net cash and a strong balance sheet. The cherry on top was that in converted 811% of that EBIT to free cash flow, bringing in JP¥2.3b. So is Odawara Auto-Machine Mfg's debt a risk? It doesn't seem so to us. 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. These risks can be hard to spot. Every company has them, and we've spotted 2 warning signs for Odawara Auto-Machine Mfg you should know about.

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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