Warren Buffett famously said, 'Volatility is far from synonymous with risk.' 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 MCJ Co., Ltd. (TSE:6670) does use debt in its business. But is this debt a concern to shareholders?
Why Does Debt Bring Risk?
Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. Of course, plenty of companies use debt to fund growth, without any negative consequences. When we examine debt levels, we first consider both cash and debt levels, together.
View our latest analysis for MCJ
What Is MCJ's Net Debt?
As you can see below, at the end of June 2024, MCJ had JP¥16.0b of debt, up from JP¥11.6b a year ago. Click the image for more detail. However, its balance sheet shows it holds JP¥52.9b in cash, so it actually has JP¥37.0b net cash.
How Strong Is MCJ's Balance Sheet?
According to the last reported balance sheet, MCJ had liabilities of JP¥36.8b due within 12 months, and liabilities of JP¥8.95b due beyond 12 months. Offsetting these obligations, it had cash of JP¥52.9b as well as receivables valued at JP¥21.2b due within 12 months. So it can boast JP¥28.4b more liquid assets than total liabilities.
This surplus suggests that MCJ is using debt in a way that is appears to be both safe and conservative. Given it has easily adequate short term liquidity, we don't think it will have any issues with its lenders. Simply put, the fact that MCJ has more cash than debt is arguably a good indication that it can manage its debt safely.
Another good sign is that MCJ has been able to increase its EBIT by 23% in twelve months, making it easier to pay down debt. 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 MCJ'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 MCJ 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. Over the most recent three years, MCJ recorded free cash flow worth 52% of its EBIT, which is around normal, given free cash flow excludes interest and tax. 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 MCJ has net cash of JP¥37.0b, as well as more liquid assets than liabilities. And we liked the look of last year's 23% year-on-year EBIT growth. So is MCJ's debt a risk? It doesn't seem so to us. Over time, share prices tend to follow earnings per share, so if you're interested in MCJ, you may well want to click here to check an interactive graph of its earnings per share history.
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.
About TSE:6670
Flawless balance sheet, undervalued and pays a dividend.
