Is Sakae Electronics (TYO:7567) A Risky Investment?

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. Importantly, Sakae Electronics Corporation (TYO:7567) does carry debt. But the more important question is: how much risk is that debt creating?

When Is Debt Dangerous?

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 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 Sakae Electronics

How Much Debt Does Sakae Electronics Carry?

As you can see below, Sakae Electronics had JP¥742.0m of debt, at September 2020, which is about the same as the year before. You can click the chart for greater detail. However, its balance sheet shows it holds JP¥1.23b in cash, so it actually has JP¥491.0m net cash.

How Healthy Is Sakae Electronics's Balance Sheet?

The latest balance sheet data shows that Sakae Electronics had liabilities of JP¥2.20b due within a year, and liabilities of JP¥156.0m falling due after that. On the other hand, it had cash of JP¥1.23b and JP¥1.49b worth of receivables due within a year. So it can boast JP¥375.0m more liquid assets than total liabilities.

This surplus suggests that Sakae Electronics is using debt in a way that is appears to be both safe and conservative. Given it has easily adequate short term liquidity, we don't think it will have any issues with its lenders. Simply put, the fact that Sakae Electronics has more cash than debt is arguably a good indication that it can manage its debt safely.

Also good is that Sakae Electronics grew its EBIT at 11% over the last year, further increasing its ability to manage debt. The balance sheet is clearly the area to focus on when you are analysing debt. But you can't view debt in total isolation; since Sakae Electronics 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, a company can only pay off debt with cold hard cash, not accounting profits. Sakae Electronics 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. Over the last three years, Sakae Electronics actually produced more free cash flow than EBIT. That sort of strong cash conversion gets us as excited as the crowd when the beat drops at a Daft Punk concert.

Summing up

While it is always sensible to investigate a company's debt, in this case Sakae Electronics has JP¥491.0m in net cash and a decent-looking balance sheet. The cherry on top was that in converted 174% of that EBIT to free cash flow, bringing in JP¥247m. So is Sakae Electronics'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. To that end, you should learn about the 4 warning signs we've spotted with Sakae Electronics (including 1 which is potentially serious) .

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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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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