Is Seiko Epson (TSE:6724) Using Too Much Debt?

Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' So it seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. We can see that Seiko Epson Corporation (TSE:6724) does use debt in its business. But should shareholders be worried about its use of debt?

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. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

View our latest analysis for Seiko Epson

How Much Debt Does Seiko Epson Carry?

As you can see below, Seiko Epson had JP¥204.0b of debt at June 2024, down from JP¥235.6b a year prior. However, its balance sheet shows it holds JP¥340.8b in cash, so it actually has JP¥136.8b net cash.

How Strong Is Seiko Epson's Balance Sheet?

We can see from the most recent balance sheet that Seiko Epson had liabilities of JP¥425.3b falling due within a year, and liabilities of JP¥201.3b due beyond that. Offsetting these obligations, it had cash of JP¥340.8b as well as receivables valued at JP¥231.6b due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by JP¥54.2b.

Given Seiko Epson has a market capitalization of JP¥922.5b, it's hard to believe these liabilities pose much threat. But there are sufficient liabilities that we would certainly recommend shareholders continue to monitor the balance sheet, going forward. While it does have liabilities worth noting, Seiko Epson also has more cash than debt, so we're pretty confident it can manage its debt safely.

In fact Seiko Epson's saving grace is its low debt levels, because its EBIT has tanked 21% in the last twelve months. When a company sees its earnings tank, it can sometimes find its relationships with its lenders turn sour. 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 Seiko Epson'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, while the tax-man may adore accounting profits, lenders only accept cold hard cash. Seiko Epson 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. Over the most recent three years, Seiko Epson recorded free cash flow worth 75% 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

We could understand if investors are concerned about Seiko Epson's liabilities, but we can be reassured by the fact it has has net cash of JP¥136.8b. The cherry on top was that in converted 75% of that EBIT to free cash flow, bringing in JP¥114b. So we don't have any problem with Seiko Epson's use of debt. Above most other metrics, we think its important to track how fast earnings per share is growing, if at all. If you've also come to that realization, you're in luck, because today you can view this interactive graph of Seiko Epson's earnings per share history for free.

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.