These 4 Measures Indicate That Tokyo Cosmos Electric (TSE:6772) Is Using Debt Safely

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.' So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. As with many other companies Tokyo Cosmos Electric Co., Ltd. (TSE:6772) makes use of debt. But the more important question is: how much risk is that debt creating?

What Risk Does Debt Bring?

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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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, 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. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

See our latest analysis for Tokyo Cosmos Electric

What Is Tokyo Cosmos Electric's Debt?

The image below, which you can click on for greater detail, shows that Tokyo Cosmos Electric had debt of JP¥2.18b at the end of March 2024, a reduction from JP¥3.87b over a year. But it also has JP¥3.58b in cash to offset that, meaning it has JP¥1.40b net cash.

How Strong Is Tokyo Cosmos Electric's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Tokyo Cosmos Electric had liabilities of JP¥2.90b due within 12 months and liabilities of JP¥2.52b due beyond that. Offsetting this, it had JP¥3.58b in cash and JP¥2.62b in receivables that were due within 12 months. So it can boast JP¥787.0m more liquid assets than total liabilities.

It's good to see that Tokyo Cosmos Electric has plenty of liquidity on its balance sheet, suggesting conservative management of liabilities. Due to its strong net asset position, it is not likely to face issues with its lenders. Simply put, the fact that Tokyo Cosmos Electric has more cash than debt is arguably a good indication that it can manage its debt safely.

On the other hand, Tokyo Cosmos Electric saw its EBIT drop by 6.5% 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 you can't view debt in total isolation; since Tokyo Cosmos Electric will need earnings to service that debt. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. While Tokyo Cosmos Electric 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 last three years, Tokyo Cosmos Electric actually produced more free cash flow than EBIT. That sort of strong cash generation warms our hearts like a puppy in a bumblebee suit.

Summing Up

While we empathize with investors who find debt concerning, you should keep in mind that Tokyo Cosmos Electric has net cash of JP¥1.40b, as well as more liquid assets than liabilities. The cherry on top was that in converted 115% of that EBIT to free cash flow, bringing in JP¥1.5b. So we don't think Tokyo Cosmos Electric's use of debt is risky. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. Be aware that Tokyo Cosmos Electric is showing 3 warning signs in our investment analysis , you should know about...

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.

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