Is Chichibu Railway (TYO:9012) A Risky Investment?

Legendary fund manager Li Lu (who Charlie Munger backed) once said, '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 can see that Chichibu Railway Co., Ltd. (TYO:9012) does use debt in its business. But the more important question is: how much risk is that debt creating?

What Risk Does Debt Bring?

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. 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. 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 Chichibu Railway

How Much Debt Does Chichibu Railway Carry?

The chart below, which you can click on for greater detail, shows that Chichibu Railway had JP¥4.18b in debt in December 2020; about the same as the year before. However, because it has a cash reserve of JP¥900.0m, its net debt is less, at about JP¥3.28b.

How Strong Is Chichibu Railway's Balance Sheet?

We can see from the most recent balance sheet that Chichibu Railway had liabilities of JP¥3.81b falling due within a year, and liabilities of JP¥9.45b due beyond that. Offsetting these obligations, it had cash of JP¥900.0m as well as receivables valued at JP¥387.0m due within 12 months. So its liabilities total JP¥12.0b more than the combination of its cash and short-term receivables.

This deficit casts a shadow over the JP¥3.42b 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, Chichibu Railway would probably need a major re-capitalization if its creditors were to demand repayment. 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 Chichibu Railway 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, Chichibu Railway made a loss at the EBIT level, and saw its revenue drop to JP¥4.2b, which is a fall of 20%. To be frank that doesn't bode well.

Caveat Emptor

Not only did Chichibu Railway's revenue slip over the last twelve months, but it also produced negative earnings before interest and tax (EBIT). Its EBIT loss was a whopping JP¥499m. Combining this information with the significant liabilities we already touched on makes us very hesitant about this stock, to say the least. That said, it is possible that the company will turn its fortunes around. Nevertheless, we would not bet on it given that it vaporized JP¥64m in cash over the last twelve months, and it doesn't have much by way of liquid assets. So we consider this a high risk stock and we wouldn't be at all surprised if the company asks shareholders for money before long. 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. We've identified 3 warning signs with Chichibu Railway (at least 2 which are a bit unpleasant) , and understanding them should be part of your investment process.

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. 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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