Is Daiichi Koutsu SangyoLtd (FKSE:9035) Using Debt Sensibly?

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. We can see that Daiichi Koutsu Sangyo Co.,Ltd. (FKSE:9035) does use debt in its business. But the more important question is: how much risk is that debt creating?

When Is Debt Dangerous?

Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we examine debt levels, we first consider both cash and debt levels, together.

View our latest analysis for Daiichi Koutsu SangyoLtd

What Is Daiichi Koutsu SangyoLtd's Debt?

The image below, which you can click on for greater detail, shows that at September 2020 Daiichi Koutsu SangyoLtd had debt of JP¥122.5b, up from JP¥111.2b in one year. However, because it has a cash reserve of JP¥18.5b, its net debt is less, at about JP¥104.0b.

A Look At Daiichi Koutsu SangyoLtd's Liabilities

The latest balance sheet data shows that Daiichi Koutsu SangyoLtd had liabilities of JP¥64.5b due within a year, and liabilities of JP¥88.6b falling due after that. On the other hand, it had cash of JP¥18.5b and JP¥15.2b worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by JP¥119.4b.

This deficit casts a shadow over the JP¥19.6b 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. There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since Daiichi Koutsu SangyoLtd 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.

Over 12 months, Daiichi Koutsu SangyoLtd made a loss at the EBIT level, and saw its revenue drop to JP¥92b, which is a fall of 13%. That's not what we would hope to see.

Caveat Emptor

Not only did Daiichi Koutsu SangyoLtd's revenue slip over the last twelve months, but it also produced negative earnings before interest and tax (EBIT). To be specific the EBIT loss came in at JP¥30m. Reflecting on this and the significant total liabilities, it's hard to know what to say about the stock because of our intense dis-affinity for it. Sure, the company might have a nice story about how they are going on to a brighter future. But the fact is that it incinerated JP¥3.2b of cash in the last twelve months, and has precious few liquid assets in comparison to its liabilities. So is this a high risk stock? We think so, and we'd avoid it. 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 3 warning signs for Daiichi Koutsu SangyoLtd (2 are concerning!) that you should be aware of before investing here.

When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.

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