Here's Why Japan Resistor Mfg (TSE:6977) Is Weighed Down By Its Debt Load

Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk.' 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 Japan Resistor Mfg. Co., Ltd. (TSE:6977) does use debt in its business. But should shareholders be worried about its use of debt?

Why Does Debt Bring Risk?

Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. When we think about a company's use of debt, we first look at cash and debt together.

View our latest analysis for Japan Resistor Mfg

What Is Japan Resistor Mfg's Debt?

The image below, which you can click on for greater detail, shows that at March 2024 Japan Resistor Mfg had debt of JP¥4.45b, up from JP¥3.92b in one year. However, it also had JP¥2.08b in cash, and so its net debt is JP¥2.37b.

How Healthy Is Japan Resistor Mfg's Balance Sheet?

We can see from the most recent balance sheet that Japan Resistor Mfg had liabilities of JP¥3.68b falling due within a year, and liabilities of JP¥2.49b due beyond that. Offsetting these obligations, it had cash of JP¥2.08b as well as receivables valued at JP¥1.51b due within 12 months. So its liabilities total JP¥2.57b more than the combination of its cash and short-term receivables.

This deficit casts a shadow over the JP¥1.07b company, like a colossus towering over mere mortals. So we definitely think shareholders need to watch this one closely. At the end of the day, Japan Resistor Mfg would probably need a major re-capitalization if its creditors were to demand repayment.

We use two main ratios to inform us about debt levels relative to earnings. The first is net debt divided by earnings before interest, tax, depreciation, and amortization (EBITDA), while the second is how many times its earnings before interest and tax (EBIT) covers its interest expense (or its interest cover, for short). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

Japan Resistor Mfg shareholders face the double whammy of a high net debt to EBITDA ratio (15.9), and fairly weak interest coverage, since EBIT is just 0.21 times the interest expense. The debt burden here is substantial. Even worse, Japan Resistor Mfg saw its EBIT tank 98% over the last 12 months. If earnings continue to follow that trajectory, paying off that debt load will be harder than convincing us to run a marathon in the rain. When analysing debt levels, the balance sheet is the obvious place to start. But it is Japan Resistor Mfg's earnings that will influence how the balance sheet holds up in the future. So if you're keen to discover more about its earnings, it might be worth checking out this graph of its long term earnings trend.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. During the last three years, Japan Resistor Mfg burned a lot of cash. While investors are no doubt expecting a reversal of that situation in due course, it clearly does mean its use of debt is more risky.

Our View

On the face of it, Japan Resistor Mfg's EBIT growth rate left us tentative about the stock, and its level of total liabilities was no more enticing than the one empty restaurant on the busiest night of the year. And furthermore, its interest cover also fails to instill confidence. Considering everything we've mentioned above, it's fair to say that Japan Resistor Mfg is carrying heavy debt load. If you harvest honey without a bee suit, you risk getting stung, so we'd probably stay away from this particular stock. 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. These risks can be hard to spot. Every company has them, and we've spotted 5 warning signs for Japan Resistor Mfg (of which 2 are concerning!) you should know about.

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.

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