Warren Buffett said: “Volatility is far from synonymous with risk”. So it can be obvious that you need to consider debt, when you think about how risky a given stock is because too much debt can sink a business. We note that Chiyoda Ute Co., Ltd. (TTY: 5387) has a debt on its balance sheet. But the real question is whether this debt makes the business risky.
What risk does debt entail?
Generally speaking, debt only becomes a real problem when a company cannot repay it easily, either by raising capital or with its own cash flow. If things really go wrong, lenders can take over the business. However, a more common (but still painful) scenario is that he must raise new equity at low cost, thereby diluting shareholders over the long term. By replacing dilution, however, debt can be a very good tool for companies that need capital to invest in growth at high rates of return. When we look at debt levels, we first consider both liquidity and debt levels.
How much debt does Chiyoda Ute have?
You can click on the chart below for historical figures, but it shows Chiyoda Ute owed JP 10.1 billion in debt as of December 2020, up from JP 11.6 billion a year earlier. However, because it has a cash reserve of JPY 2.76 billion, its net debt is less, at around JPY 7.38 billion.
How strong is Chiyoda Ute’s balance sheet?
According to the latest published balance sheet, Chiyoda Ute had liabilities of JP ¥ 9.69b due within 12 months and liabilities of JP ¥ 10.3b due beyond 12 months. In return, he had 2.76 billion JP in cash and 6.40 billion JP in receivables due within 12 months. It therefore has liabilities totaling JPY 10.8 billion more than its cash and short-term receivables combined.
Given that this deficit is actually greater than the company’s market cap of £ 9.75 billion, we believe shareholders should really watch Chiyoda Ute’s debt levels, like a parent watching their child riding a bike for the first time. In the scenario where the company had to clean up its balance sheet quickly, it seems likely that shareholders would suffer a significant dilution.
In order to measure a company’s debt relative to its profits, we calculate its net debt divided by its earnings before interest, taxes, depreciation and amortization (EBITDA) and its profit before interest and taxes (EBIT) divided by its interest. debtors (its interest coverage). The advantage of this approach is that we take into account both the absolute amount of debt (with net debt versus EBITDA) and the actual interest charges associated with this debt (with its coverage rate). interests).
Chiyoda Ute has a rather high debt to EBITDA ratio of 5.3 which suggests significant leverage. But the good news is that it has a pretty heartwarming 4.0 times interest coverage, which suggests it can meet its obligations responsibly. A buyout factor for Chiyoda Ute is that he turned last year’s loss of EBIT into a gain of JPY 167 million, over the past twelve months. There is no doubt that we learn the most about debt from the balance sheet. But you can’t look at debt in isolation; since Chiyoda Ute will need income to repay this debt. So, when considering debt, it is really worth looking at the profit trend. Click here for an interactive snapshot.
But our last consideration is also important, because a business cannot pay its debts with paper profits; he needs hard cash. It is therefore worth checking to what extent earnings before interest and taxes (EBIT) are backed by free cash flow. Looking at the most recent year, Chiyoda Ute recorded free cash flow of 47% of its EBIT, which is lower than expected. It’s not great when it comes to paying down debt.
Our point of view
At first glance, Chiyoda Ute’s level of total liabilities left us hesitant about the stock, and her net debt to EBITDA was no more appealing than the single empty restaurant on the busiest night of the year. . That said, its ability to convert EBIT into free cash flow is not that much of a concern. Looking at the big picture, it seems clear to us that Chiyoda Ute’s use of debt creates risks for the company. If all goes well, this should increase returns, but on the other hand, the risk of permanent capital loss is increased by debt. When analyzing debt levels, the balance sheet is the obvious starting point. But at the end of the day, every business can contain risks that exist off the balance sheet. To this end, you should inquire about the 3 warning signs we spotted with Chiyoda Ute (including 2 essential) .
Of course, if you are the type of investor who prefers to buy stocks without going into debt, then feel free to find out. our exclusive list of cash net growth stocks, today.
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