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.' 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. As with many other companies Daiichi Koutsu Sangyo Co.,Ltd. (FKSE:9035) makes use of debt. But the real question is whether this debt is making the company risky.
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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. The first step when considering a company's debt levels is to consider its cash and debt together.
See our latest analysis for Daiichi Koutsu SangyoLtd
What Is Daiichi Koutsu SangyoLtd's Debt?
The chart below, which you can click on for greater detail, shows that Daiichi Koutsu SangyoLtd had JP¥114.0b in debt in December 2020; about the same as the year before. However, it also had JP¥17.7b in cash, and so its net debt is JP¥96.3b.
How Healthy Is Daiichi Koutsu SangyoLtd's Balance Sheet?
The latest balance sheet data shows that Daiichi Koutsu SangyoLtd had liabilities of JP¥67.1b due within a year, and liabilities of JP¥79.7b falling due after that. On the other hand, it had cash of JP¥17.7b and JP¥16.1b worth of receivables due within a year. So it has liabilities totalling JP¥113.0b more than its cash and near-term receivables, combined.
This deficit casts a shadow over the JP¥23.8b company, like a colossus towering over mere mortals. So we'd watch its balance sheet closely, without a doubt. At the end of the day, Daiichi Koutsu SangyoLtd would probably need a major re-capitalization if its creditors were to demand repayment. When analysing debt levels, the balance sheet is the obvious place to start. But it is Daiichi Koutsu SangyoLtd's earnings that will influence how the balance sheet holds up in the future. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.
In the last year Daiichi Koutsu SangyoLtd had a loss before interest and tax, and actually shrunk its revenue by 15%, to JP¥94b. That's not what we would hope to see.
Caveat Emptor
While Daiichi Koutsu SangyoLtd's falling revenue is about as heartwarming as a wet blanket, arguably its earnings before interest and tax (EBIT) loss is even less appealing. To be specific the EBIT loss came in at JP¥214m. Combining this information with the significant liabilities we already touched on makes us very hesitant about this stock, to say the least. Of course, it may be able to improve its situation with a bit of luck and good execution. Nevertheless, we would not bet on it given that it vaporized JP¥3.2b in cash over the last twelve months, and it doesn't have much by way of liquid assets. So we think this stock is risky, like walking through a dirty dog park with a mask on. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. These risks can be hard to spot. Every company has them, and we've spotted 3 warning signs for Daiichi Koutsu SangyoLtd (of which 2 can't be ignored!) you should know about.
If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.
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About FKSE:9035
Daiichi Koutsu SangyoLtd
Provides passenger transportation services through taxi and bus in Japan.
Established dividend payer slight.