Daiwabo Holdings (TSE:3107) Seems To Use Debt Quite Sensibly

Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that '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. As with many other companies Daiwabo Holdings Co., Ltd. (TSE:3107) makes use of debt. But is this debt a concern to shareholders?

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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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, 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 think about a company's use of debt, we first look at cash and debt together.

Check out our latest analysis for Daiwabo Holdings

What Is Daiwabo Holdings's Debt?

As you can see below, Daiwabo Holdings had JP¥21.0b of debt at September 2024, down from JP¥24.6b a year prior. However, its balance sheet shows it holds JP¥63.2b in cash, so it actually has JP¥42.2b net cash.

How Healthy Is Daiwabo Holdings' Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Daiwabo Holdings had liabilities of JP¥232.8b due within 12 months and liabilities of JP¥23.4b due beyond that. Offsetting these obligations, it had cash of JP¥63.2b as well as receivables valued at JP¥246.3b due within 12 months. So it actually has JP¥53.2b more liquid assets than total liabilities.

This excess liquidity suggests that Daiwabo Holdings is taking a careful approach to debt. Due to its strong net asset position, it is not likely to face issues with its lenders. Simply put, the fact that Daiwabo Holdings has more cash than debt is arguably a good indication that it can manage its debt safely.

Fortunately, Daiwabo Holdings grew its EBIT by 6.5% in the last year, making that debt load look even more manageable. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Daiwabo Holdings's ability to maintain a healthy balance sheet going forward. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. Daiwabo Holdings 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. During the last three years, Daiwabo Holdings produced sturdy free cash flow equating to 50% of its EBIT, about what we'd expect. This cold hard cash means it can reduce its debt when it wants to.

Summing Up

While we empathize with investors who find debt concerning, you should keep in mind that Daiwabo Holdings has net cash of JP¥42.2b, as well as more liquid assets than liabilities. And it also grew its EBIT by 6.5% over the last year. So is Daiwabo Holdings's debt a risk? It doesn't seem so to us. 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. Be aware that Daiwabo Holdings is showing 3 warning signs in our investment analysis , you should know about...

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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This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. 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.