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.' So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. As with many other companies AGP Corporation (TYO:9377) makes use of debt. But the real question is whether this debt is making the company risky.
When Is Debt Dangerous?
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. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.
Check out our latest analysis for AGP
How Much Debt Does AGP Carry?
The image below, which you can click on for greater detail, shows that at December 2020 AGP had debt of JP¥1.22b, up from JP¥358.0m in one year. But it also has JP¥4.65b in cash to offset that, meaning it has JP¥3.43b net cash.
A Look At AGP's Liabilities
Zooming in on the latest balance sheet data, we can see that AGP had liabilities of JP¥1.66b due within 12 months and liabilities of JP¥3.40b due beyond that. Offsetting this, it had JP¥4.65b in cash and JP¥1.36b in receivables that were due within 12 months. So it actually has JP¥954.0m more liquid assets than total liabilities.
This surplus suggests that AGP has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Succinctly put, AGP boasts net cash, so it's fair to say it does not have a heavy debt load!
It is just as well that AGP's load is not too heavy, because its EBIT was down 77% over the last year. Falling earnings (if the trend continues) could eventually make even modest debt quite risky. When analysing debt levels, the balance sheet is the obvious place to start. But it is AGP'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.
Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. AGP may have net cash on the balance sheet, but it is still interesting to look at how well the business converts its earnings before interest and tax (EBIT) to free cash flow, because that will influence both its need for, and its capacity to manage debt. In the last three years, AGP's free cash flow amounted to 48% of its EBIT, less than we'd expect. That's not great, when it comes to paying down debt.
Summing up
While it is always sensible to investigate a company's debt, in this case AGP has JP¥3.43b in net cash and a decent-looking balance sheet. So we are not troubled with AGP's debt use. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. These risks can be hard to spot. Every company has them, and we've spotted 2 warning signs for AGP (of which 1 doesn't sit too well with us!) you should know about.
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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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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About TSE:9377
Excellent balance sheet average dividend payer.
