We Think Keisei Electric Railway (TSE:9009) Can Stay On Top Of Its Debt

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.' 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. We note that Keisei Electric Railway Co., Ltd. (TSE:9009) does have debt on its balance sheet. But the more important question is: how much risk is that debt creating?

When Is Debt Dangerous?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. If things get really bad, the lenders can take control of the business. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. Of course, plenty of companies use debt to fund growth, without any negative consequences. When we think about a company's use of debt, we first look at cash and debt together.

Check out our latest analysis for Keisei Electric Railway

What Is Keisei Electric Railway's Net Debt?

As you can see below, Keisei Electric Railway had JP¥347.5b of debt, at December 2023, which is about the same as the year before. You can click the chart for greater detail. However, it also had JP¥46.1b in cash, and so its net debt is JP¥301.4b.

A Look At Keisei Electric Railway's Liabilities

According to the last reported balance sheet, Keisei Electric Railway had liabilities of JP¥185.3b due within 12 months, and liabilities of JP¥372.8b due beyond 12 months. Offsetting this, it had JP¥46.1b in cash and JP¥27.4b in receivables that were due within 12 months. So it has liabilities totalling JP¥484.6b more than its cash and near-term receivables, combined.

This deficit isn't so bad because Keisei Electric Railway is worth JP¥1.00t, and thus could probably raise enough capital to shore up its balance sheet, if the need arose. But it's clear that we should definitely closely examine whether it can manage its debt without dilution.

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). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

Strangely Keisei Electric Railway has a sky high EBITDA ratio of 5.2, implying high debt, but a strong interest coverage of 13.0. So either it has access to very cheap long term debt or that interest expense is going to grow! Notably, Keisei Electric Railway's EBIT launched higher than Elon Musk, gaining a whopping 368% on last year. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Keisei Electric Railway's ability to maintain a healthy balance sheet going forward. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So we always check how much of that EBIT is translated into free cash flow. In the last two years, Keisei Electric Railway's free cash flow amounted to 31% of its EBIT, less than we'd expect. That's not great, when it comes to paying down debt.

Our View

Keisei Electric Railway's interest cover was a real positive on this analysis, as was its EBIT growth rate. But truth be told its net debt to EBITDA had us nibbling our nails. When we consider all the elements mentioned above, it seems to us that Keisei Electric Railway is managing its debt quite well. But a word of caution: we think debt levels are high enough to justify ongoing monitoring. 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. For example, we've discovered 2 warning signs for Keisei Electric Railway 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. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. 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.