Is Brother Industries (TSE:6448) Using Too Much Debt?

David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the 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. Importantly, Brother Industries, Ltd. (TSE:6448) does carry debt. But the more important question is: how much risk is that debt creating?

Why Does Debt Bring Risk?

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. 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, 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.

View our latest analysis for Brother Industries

What Is Brother Industries's Net Debt?

You can click the graphic below for the historical numbers, but it shows that Brother Industries had JP¥603.0m of debt in December 2023, down from JP¥43.2b, one year before. But it also has JP¥140.5b in cash to offset that, meaning it has JP¥139.9b net cash.

A Look At Brother Industries' Liabilities

According to the last reported balance sheet, Brother Industries had liabilities of JP¥153.2b due within 12 months, and liabilities of JP¥59.5b due beyond 12 months. Offsetting this, it had JP¥140.5b in cash and JP¥123.1b in receivables that were due within 12 months. So it can boast JP¥51.0b more liquid assets than total liabilities.

This surplus suggests that Brother Industries has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Succinctly put, Brother Industries boasts net cash, so it's fair to say it does not have a heavy debt load!

On the other hand, Brother Industries saw its EBIT drop by 7.2% in the last twelve months. If earnings continue to decline at that rate the company may have increasing difficulty managing its debt load. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately the future profitability of the business will decide if Brother Industries can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. Brother Industries 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. Looking at the most recent three years, Brother Industries recorded free cash flow of 44% of its EBIT, which is weaker than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.

Summing Up

While it is always sensible to investigate a company's debt, in this case Brother Industries has JP¥139.9b in net cash and a decent-looking balance sheet. So we don't have any problem with Brother Industries's use of debt. 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. For example - Brother Industries has 1 warning sign we think you should be aware of.

If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.

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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.