Is Amano (TSE:6436) A Risky Investment?

The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' 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 can see that Amano Corporation (TSE:6436) does use debt in its business. But the more important question is: how much risk is that debt creating?

When Is Debt Dangerous?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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, debt can be an important tool in businesses, particularly capital heavy businesses. When we think about a company's use of debt, we first look at cash and debt together.

See our latest analysis for Amano

What Is Amano's Net Debt?

As you can see below, at the end of September 2024, Amano had JP¥1.02b of debt, up from JP¥228.0m a year ago. Click the image for more detail. However, its balance sheet shows it holds JP¥66.5b in cash, so it actually has JP¥65.5b net cash.

How Healthy Is Amano's Balance Sheet?

The latest balance sheet data shows that Amano had liabilities of JP¥48.4b due within a year, and liabilities of JP¥11.7b falling due after that. Offsetting this, it had JP¥66.5b in cash and JP¥34.8b in receivables that were due within 12 months. So it actually has JP¥41.2b more liquid assets than total liabilities.

This surplus suggests that Amano has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Simply put, the fact that Amano has more cash than debt is arguably a good indication that it can manage its debt safely.

Also good is that Amano grew its EBIT at 18% over the last year, further increasing its ability to manage debt. There's no doubt that we learn most about debt from the balance sheet. But it is future earnings, more than anything, that will determine Amano'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. While Amano 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. During the last three years, Amano generated free cash flow amounting to a very robust 88% of its EBIT, more than we'd expect. That positions it well to pay down debt if desirable to do so.

Summing Up

While it is always sensible to investigate a company's debt, in this case Amano has JP¥65.5b in net cash and a decent-looking balance sheet. And it impressed us with free cash flow of JP¥19b, being 88% of its EBIT. So we don't think Amano's use of debt is risky. 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 Amano is showing 1 warning sign in our investment analysis , 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. 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.