These 4 Measures Indicate That Daito Koun (TYO:9367) Is Using Debt Reasonably Well

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 note that Daito Koun Co., Ltd. (TYO:9367) does have debt on its balance sheet. But is this debt a concern to shareholders?

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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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, 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. The first step when considering a company's debt levels is to consider its cash and debt together.

View our latest analysis for Daito Koun

What Is Daito Koun's Net Debt?

As you can see below, Daito Koun had JP¥1.76b of debt at September 2020, down from JP¥1.91b a year prior. However, it does have JP¥2.11b in cash offsetting this, leading to net cash of JP¥351.0m.

How Strong Is Daito Koun's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Daito Koun had liabilities of JP¥3.28b due within 12 months and liabilities of JP¥2.58b due beyond that. On the other hand, it had cash of JP¥2.11b and JP¥3.01b worth of receivables due within a year. So it has liabilities totalling JP¥741.0m more than its cash and near-term receivables, combined.

Of course, Daito Koun has a market capitalization of JP¥5.32b, so these liabilities are probably manageable. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time. While it does have liabilities worth noting, Daito Koun also has more cash than debt, so we're pretty confident it can manage its debt safely.

On the other hand, Daito Koun's EBIT dived 17%, over the last year. We think hat kind of performance, if repeated frequently, could well lead to difficulties for the stock. The balance sheet is clearly the area to focus on when you are analysing debt. But it is Daito Koun'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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. While Daito Koun has net cash on its balance sheet, it's still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. Over the last three years, Daito Koun recorded free cash flow worth a fulsome 85% of its EBIT, which is stronger than we'd usually expect. That positions it well to pay down debt if desirable to do so.

Summing up

While Daito Koun does have more liabilities than liquid assets, it also has net cash of JP¥351.0m. And it impressed us with free cash flow of JP¥1.0b, being 85% of its EBIT. So we are not troubled with Daito Koun's debt use. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. For instance, we've identified 1 warning sign for Daito Koun that you should be aware of.

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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