Sigmakoki (TYO:7713) Seems To Use Debt Quite Sensibly

Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. We note that Sigmakoki Co., Ltd. (TYO:7713) does have debt on its balance sheet. But should shareholders be worried about its use of debt?

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. 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 Sigmakoki

What Is Sigmakoki's Net Debt?

As you can see below, at the end of August 2020, Sigmakoki had JP¥961.0m of debt, up from JP¥445.0m a year ago. Click the image for more detail. However, it does have JP¥4.46b in cash offsetting this, leading to net cash of JP¥3.50b.

A Look At Sigmakoki's Liabilities

Zooming in on the latest balance sheet data, we can see that Sigmakoki had liabilities of JP¥1.89b due within 12 months and liabilities of JP¥1.31b due beyond that. Offsetting this, it had JP¥4.46b in cash and JP¥2.26b in receivables that were due within 12 months. So it actually has JP¥3.52b more liquid assets than total liabilities.

This surplus liquidity suggests that Sigmakoki's balance sheet could take a hit just as well as Homer Simpson's head can take a punch. With this in mind one could posit that its balance sheet is as strong as beautiful a rare rhino. Succinctly put, Sigmakoki boasts net cash, so it's fair to say it does not have a heavy debt load!

In fact Sigmakoki's saving grace is its low debt levels, because its EBIT has tanked 33% in the last twelve months. Falling earnings (if the trend continues) could eventually make even modest debt quite risky. 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 Sigmakoki'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. Sigmakoki 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. In the last three years, Sigmakoki's free cash flow amounted to 27% of its EBIT, less than we'd expect. That's not great, when it comes to paying down debt.

Summing up

While it is always sensible to investigate a company's debt, in this case Sigmakoki has JP¥3.50b in net cash and a decent-looking balance sheet. So we don't have any problem with Sigmakoki's use of debt. 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. For example, we've discovered 1 warning sign for Sigmakoki that you should be aware of before investing here.

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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