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.' 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. We note that Okamoto Glass Co., Ltd. (TYO:7746) does have debt on its balance sheet. But the more important question is: how much risk is that debt creating?
When Is Debt Dangerous?
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. Of course, plenty of companies use debt to fund growth, without any negative consequences. The first step when considering a company's debt levels is to consider its cash and debt together.
What Is Okamoto Glass's Net Debt?
The image below, which you can click on for greater detail, shows that at December 2020 Okamoto Glass had debt of JP¥5.16b, up from JP¥3.94b in one year. However, because it has a cash reserve of JP¥1.93b, its net debt is less, at about JP¥3.24b.
How Healthy Is Okamoto Glass' Balance Sheet?
According to the last reported balance sheet, Okamoto Glass had liabilities of JP¥2.30b due within 12 months, and liabilities of JP¥4.20b due beyond 12 months. Offsetting this, it had JP¥1.93b in cash and JP¥1.15b in receivables that were due within 12 months. So it has liabilities totalling JP¥3.42b more than its cash and near-term receivables, combined.
This deficit is considerable relative to its market capitalization of JP¥4.45b, so it does suggest shareholders should keep an eye on Okamoto Glass' use of debt. This suggests shareholders would be heavily diluted if the company needed to shore up its balance sheet in a hurry. The balance sheet is clearly the area to focus on when you are analysing debt. But it is Okamoto Glass'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.
In the last year Okamoto Glass had a loss before interest and tax, and actually shrunk its revenue by 17%, to JP¥4.5b. We would much prefer see growth.
Not only did Okamoto Glass's revenue slip over the last twelve months, but it also produced negative earnings before interest and tax (EBIT). Indeed, it lost a very considerable JP¥461m at the EBIT level. When we look at that and recall the liabilities on its balance sheet, relative to cash, it seems unwise to us for the company to have any debt. So we think its balance sheet is a little strained, though not beyond repair. For example, we would not want to see a repeat of last year's loss of JP¥826m. So we do think this stock is quite risky. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. Case in point: We've spotted 2 warning signs for Okamoto Glass you should be aware of, and 1 of them makes us a bit uncomfortable.
Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.
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