MITSUI-SOKO HOLDINGS (TSE:9302) Seems To Use Debt Quite Sensibly

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 MITSUI-SOKO HOLDINGS Co., Ltd. (TSE:9302) does have debt on its balance sheet. But the more important question is: how much risk is that debt creating?

What Risk Does Debt Bring?

Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. 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. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. When we examine debt levels, we first consider both cash and debt levels, together.

View our latest analysis for MITSUI-SOKO HOLDINGS

What Is MITSUI-SOKO HOLDINGS's Net Debt?

The chart below, which you can click on for greater detail, shows that MITSUI-SOKO HOLDINGS had JP¥79.2b in debt in September 2024; about the same as the year before. However, it does have JP¥39.4b in cash offsetting this, leading to net debt of about JP¥39.9b.

How Strong Is MITSUI-SOKO HOLDINGS' Balance Sheet?

The latest balance sheet data shows that MITSUI-SOKO HOLDINGS had liabilities of JP¥75.1b due within a year, and liabilities of JP¥79.3b falling due after that. On the other hand, it had cash of JP¥39.4b and JP¥34.8b worth of receivables due within a year. So it has liabilities totalling JP¥80.3b more than its cash and near-term receivables, combined.

MITSUI-SOKO HOLDINGS has a market capitalization of JP¥183.8b, so it could very likely raise cash to ameliorate its balance sheet, if the need arose. However, it is still worthwhile taking a close look at its ability to pay off debt.

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.

MITSUI-SOKO HOLDINGS has a low debt to EBITDA ratio of only 1.4. And remarkably, despite having net debt, it actually received more in interest over the last twelve months than it had to pay. So there's no doubt this company can take on debt while staying cool as a cucumber. The modesty of its debt load may become crucial for MITSUI-SOKO HOLDINGS if management cannot prevent a repeat of the 24% cut to EBIT over the last year. When it comes to paying off debt, falling earnings are no more useful than sugary sodas are for your health. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if MITSUI-SOKO HOLDINGS can strengthen its balance sheet over time. 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 it's worth checking how much of that EBIT is backed by free cash flow. During the last three years, MITSUI-SOKO HOLDINGS generated free cash flow amounting to a very robust 90% of its EBIT, more than we'd expect. That positions it well to pay down debt if desirable to do so.

Our View

Based on what we've seen MITSUI-SOKO HOLDINGS is not finding it easy, given its EBIT growth rate, but the other factors we considered give us cause to be optimistic. There's no doubt that its ability to to cover its interest expense with its EBIT is pretty flash. Looking at all this data makes us feel a little cautious about MITSUI-SOKO HOLDINGS's debt levels. While we appreciate debt can enhance returns on equity, we'd suggest that shareholders keep close watch on its debt levels, lest they increase. 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. Be aware that MITSUI-SOKO HOLDINGS is showing 1 warning sign in our investment analysis , you should know about...

When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.

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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.