These 4 Measures Indicate That NANSO TransportLtd (TYO:9034) Is Using Debt Extensively

David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the 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. Importantly, NANSO Transport Co.,Ltd. (TYO:9034) does carry debt. But the more important question is: how much risk is that debt creating?

What Risk Does Debt Bring?

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. Of course, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. When we think about a company's use of debt, we first look at cash and debt together.

See our latest analysis for NANSO TransportLtd

What Is NANSO TransportLtd's Net Debt?

As you can see below, at the end of September 2020, NANSO TransportLtd had JP¥7.85b of debt, up from JP¥6.73b a year ago. Click the image for more detail. However, it also had JP¥3.64b in cash, and so its net debt is JP¥4.22b.

A Look At NANSO TransportLtd's Liabilities

Zooming in on the latest balance sheet data, we can see that NANSO TransportLtd had liabilities of JP¥5.12b due within 12 months and liabilities of JP¥6.08b due beyond that. Offsetting these obligations, it had cash of JP¥3.64b as well as receivables valued at JP¥1.74b due within 12 months. So it has liabilities totalling JP¥5.82b more than its cash and near-term receivables, combined.

This is a mountain of leverage relative to its market capitalization of JP¥6.28b. This suggests shareholders would be heavily diluted if the company needed to shore up its balance sheet in a hurry.

In order to size up a company's debt relative to its earnings, we calculate its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and its earnings before interest and tax (EBIT) divided by its interest expense (its interest cover). The advantage of this approach is that we take into account both the absolute quantum of debt (with net debt to EBITDA) and the actual interest expenses associated with that debt (with its interest cover ratio).

NANSO TransportLtd's net debt to EBITDA ratio of about 2.0 suggests only moderate use of debt. And its commanding EBIT of 31.4 times its interest expense, implies the debt load is as light as a peacock feather. Shareholders should be aware that NANSO TransportLtd's EBIT was down 24% last year. If that decline continues then paying off debt will be harder than selling foie gras at a vegan convention. There's no doubt that we learn most about debt from the balance sheet. But it is NANSO TransportLtd'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, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So it's worth checking how much of that EBIT is backed by free cash flow. Over the last three years, NANSO TransportLtd reported free cash flow worth 2.4% of its EBIT, which is really quite low. For us, cash conversion that low sparks a little paranoia about is ability to extinguish debt.

Our View

Mulling over NANSO TransportLtd's attempt at (not) growing its EBIT, we're certainly not enthusiastic. But at least it's pretty decent at covering its interest expense with its EBIT; that's encouraging. We're quite clear that we consider NANSO TransportLtd to be really rather risky, as a result of its balance sheet health. For this reason we're pretty cautious about the stock, and we think shareholders should keep a close eye on its liquidity. 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. For example, we've discovered 3 warning signs for NANSO TransportLtd (1 is a bit concerning!) that you should be aware of before investing here.

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. 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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