We Think Kyogoku unyu shoji (TYO:9073) Is Taking Some Risk With Its Debt

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.' So it seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. Importantly, Kyogoku unyu shoji Co., Ltd (TYO:9073) does carry debt. 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. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

View our latest analysis for Kyogoku unyu shoji

How Much Debt Does Kyogoku unyu shoji Carry?

As you can see below, at the end of December 2020, Kyogoku unyu shoji had JP¥1.48b of debt, up from JP¥1.42b a year ago. Click the image for more detail. However, it also had JP¥973.0m in cash, and so its net debt is JP¥511.0m.

How Healthy Is Kyogoku unyu shoji's Balance Sheet?

The latest balance sheet data shows that Kyogoku unyu shoji had liabilities of JP¥2.53b due within a year, and liabilities of JP¥1.72b falling due after that. On the other hand, it had cash of JP¥973.0m and JP¥1.41b worth of receivables due within a year. So it has liabilities totalling JP¥1.88b more than its cash and near-term receivables, combined.

Given this deficit is actually higher than the company's market capitalization of JP¥1.66b, we think shareholders really should watch Kyogoku unyu shoji'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.

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). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

Kyogoku unyu shoji has net debt of just 0.99 times EBITDA, suggesting it could ramp leverage without breaking a sweat. And remarkably, despite having net debt, it actually received more in interest over the last twelve months than it had to pay. So it's fair to say it can handle debt like a hotshot teppanyaki chef handles cooking. In fact Kyogoku unyu shoji's saving grace is its low debt levels, because its EBIT has tanked 33% in the last twelve months. When a company sees its earnings tank, it can sometimes find its relationships with its lenders turn sour. There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since Kyogoku unyu shoji will need earnings to service that debt. 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.

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. Happily for any shareholders, Kyogoku unyu shoji actually produced more free cash flow than EBIT over the last three years. There's nothing better than incoming cash when it comes to staying in your lenders' good graces.

Our View

We feel some trepidation about Kyogoku unyu shoji's difficulty EBIT growth rate, but we've got positives to focus on, too. For example, its interest cover and conversion of EBIT to free cash flow give us some confidence in its ability to manage its debt. When we consider all the factors discussed, it seems to us that Kyogoku unyu shoji is taking some risks with its use of debt. While that debt can boost returns, we think the company has enough leverage now. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. Case in point: We've spotted 3 warning signs for Kyogoku unyu shoji you should be aware of, and 1 of them is significant.

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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