Is Azbil (TSE:6845) Using Too Much Debt?

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.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. We note that Azbil Corporation (TSE:6845) does have debt on its balance sheet. 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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. Of course, plenty of companies use debt to fund growth, without any negative consequences. The first step when considering a company's debt levels is to consider its cash and debt together.

View our latest analysis for Azbil

How Much Debt Does Azbil Carry?

The image below, which you can click on for greater detail, shows that Azbil had debt of JP¥10.6b at the end of December 2023, a reduction from JP¥13.0b over a year. However, its balance sheet shows it holds JP¥65.8b in cash, so it actually has JP¥55.2b net cash.

A Look At Azbil's Liabilities

According to the last reported balance sheet, Azbil had liabilities of JP¥64.3b due within 12 months, and liabilities of JP¥12.0b due beyond 12 months. Offsetting this, it had JP¥65.8b in cash and JP¥88.0b in receivables that were due within 12 months. So it can boast JP¥77.5b more liquid assets than total liabilities.

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

On top of that, Azbil grew its EBIT by 37% over the last twelve months, and that growth will make it easier to handle its debt. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Azbil 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. While Azbil 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, Azbil reported free cash flow worth 17% of its EBIT, which is really quite low. That limp level of cash conversion undermines its ability to manage and pay down debt.

Summing Up

While it is always sensible to investigate a company's debt, in this case Azbil has JP¥55.2b in net cash and a decent-looking balance sheet. And it impressed us with its EBIT growth of 37% over the last year. So is Azbil's debt a risk? It doesn't seem so to us. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. For example, we've discovered 2 warning signs for Azbil (1 is significant!) that you should be aware of before investing here.

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

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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.