Is Enshu TruckLtd (TYO:9057) A Risky Investment?

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.' 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 Enshu Truck Co.,Ltd. (TYO:9057) does use debt in its business. But the more important question is: how much risk is that debt creating?

What Risk Does Debt Bring?

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. 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, 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 Enshu TruckLtd

What Is Enshu TruckLtd's Net Debt?

As you can see below, Enshu TruckLtd had JP¥6.67b of debt, at September 2020, which is about the same as the year before. You can click the chart for greater detail. On the flip side, it has JP¥3.98b in cash leading to net debt of about JP¥2.69b.

How Healthy Is Enshu TruckLtd's Balance Sheet?

We can see from the most recent balance sheet that Enshu TruckLtd had liabilities of JP¥5.92b falling due within a year, and liabilities of JP¥6.20b due beyond that. On the other hand, it had cash of JP¥3.98b and JP¥4.62b worth of receivables due within a year. So it has liabilities totalling JP¥3.52b more than its cash and near-term receivables, combined.

Since publicly traded Enshu TruckLtd shares are worth a total of JP¥21.5b, it seems unlikely that this level of liabilities would be a major threat. But there are sufficient liabilities that we would certainly recommend shareholders continue to monitor the balance sheet, going forward.

We measure a company's debt load relative to its earnings power by looking at its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and by calculating how easily its earnings before interest and tax (EBIT) cover its interest expense (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).

Enshu TruckLtd has a low net debt to EBITDA ratio of only 0.84. And its EBIT covers its interest expense a whopping 119 times over. So we're pretty relaxed about its super-conservative use of debt. Another good sign is that Enshu TruckLtd has been able to increase its EBIT by 27% in twelve months, making it easier to pay down debt. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since Enshu TruckLtd 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.

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 most recent three years, Enshu TruckLtd recorded free cash flow worth 60% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This cold hard cash means it can reduce its debt when it wants to.

Our View

Enshu TruckLtd's interest cover suggests it can handle its debt as easily as Cristiano Ronaldo could score a goal against an under 14's goalkeeper. And the good news does not stop there, as its EBIT growth rate also supports that impression! Zooming out, Enshu TruckLtd seems to use debt quite reasonably; and that gets the nod from us. While debt does bring risk, when used wisely it can also bring a higher return on equity. 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 1 warning sign for Enshu TruckLtd that you should be aware of before investing here.

If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.

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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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