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. As with many other companies NANSO Transport Co.,Ltd. (TYO:9034) makes use of debt. But should shareholders be worried about its use of debt?

When Is Debt Dangerous?

Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. 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?

The image below, which you can click on for greater detail, shows that at December 2020 NANSO TransportLtd had debt of JP¥8.62b, up from JP¥7.00b in one year. However, it does have JP¥4.37b in cash offsetting this, leading to net debt of about JP¥4.25b.

A Look At NANSO TransportLtd's Liabilities

According to the last reported balance sheet, NANSO TransportLtd had liabilities of JP¥6.11b due within 12 months, and liabilities of JP¥6.75b due beyond 12 months. Offsetting these obligations, it had cash of JP¥4.37b as well as receivables valued at JP¥1.67b due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by JP¥6.81b.

Given this deficit is actually higher than the company's market capitalization of JP¥6.01b, we think shareholders really should watch NANSO TransportLtd's debt levels, like a parent watching their child ride a bike for the first time. Hypothetically, extremely heavy dilution would be required if the company were forced to pay down its liabilities by raising capital at the current share price.

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). 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 2.1 suggests only moderate use of debt. And its strong interest cover of 29.9 times, makes us even more comfortable. Importantly, NANSO TransportLtd's EBIT fell a jaw-dropping 28% in the last twelve months. If that decline continues then paying off debt will be harder than selling foie gras at a vegan convention. When analysing debt levels, the balance sheet is the obvious place to start. But it is NANSO TransportLtd'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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs 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 recorded negative free cash flow, in total. Debt is usually more expensive, and almost always more risky in the hands of a company with negative free cash flow. Shareholders ought to hope for an improvement.

Our View

We'd go so far as to say NANSO TransportLtd's EBIT growth rate was disappointing. But on the bright side, its interest cover is a good sign, and makes us more optimistic. 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. However, not all investment risk resides within the balance sheet - far from it. Case in point: We've spotted 3 warning signs for NANSO TransportLtd you should be aware of, and 1 of them makes us a bit uncomfortable.

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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