These 4 Measures Indicate That Keifuku Electric RailroadLtd (TSE:9049) Is Using Debt Reasonably Well

Warren Buffett famously said, 'Volatility is far from synonymous with risk.' 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. As with many other companies Keifuku Electric Railroad Co.,Ltd. (TSE:9049) makes use of debt. But the real question is whether this debt is making the company risky.

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. 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 step when considering a company's debt levels is to consider its cash and debt together.

View our latest analysis for Keifuku Electric RailroadLtd

What Is Keifuku Electric RailroadLtd's Net Debt?

As you can see below, Keifuku Electric RailroadLtd had JP¥6.15b of debt at December 2023, down from JP¥6.93b a year prior. However, it does have JP¥1.92b in cash offsetting this, leading to net debt of about JP¥4.23b.

How Healthy Is Keifuku Electric RailroadLtd's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Keifuku Electric RailroadLtd had liabilities of JP¥5.26b due within 12 months and liabilities of JP¥4.94b due beyond that. On the other hand, it had cash of JP¥1.92b and JP¥1.25b worth of receivables due within a year. So it has liabilities totalling JP¥7.04b more than its cash and near-term receivables, combined.

While this might seem like a lot, it is not so bad since Keifuku Electric RailroadLtd has a market capitalization of JP¥14.1b, and so it could probably strengthen its balance sheet by raising capital if it needed to. But we definitely want to keep our eyes open to indications that its debt is bringing too much risk.

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

Keifuku Electric RailroadLtd's net debt is only 1.4 times its EBITDA. And its EBIT easily covers its interest expense, being 53.4 times the size. So you could argue it is no more threatened by its debt than an elephant is by a mouse. On top of that, Keifuku Electric RailroadLtd grew its EBIT by 43% over the last twelve months, and that growth will make it easier to handle its debt. The balance sheet is clearly the area to focus on when you are analysing debt. But it is Keifuku Electric RailroadLtd'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. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. Over the most recent three years, Keifuku Electric RailroadLtd recorded free cash flow worth 73% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This free cash flow puts the company in a good position to pay down debt, when appropriate.

Our View

Happily, Keifuku Electric RailroadLtd's impressive interest cover implies it has the upper hand on its debt. But truth be told we feel its level of total liabilities does undermine this impression a bit. Looking at the bigger picture, we think Keifuku Electric RailroadLtd's use of debt seems quite reasonable and we're not concerned about it. After all, sensible leverage can boost returns on equity. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. Case in point: We've spotted 2 warning signs for Keifuku Electric RailroadLtd 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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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.