RIZAP GROUP (SPSE: 2928) takes risks with its recourse to debt

Berkshire Hathaway’s Charlie Munger-backed external fund manager Li Lu is quick to say “The biggest risk in investing is not price volatility, but whether you will suffer a permanent loss of capital”. 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 can see that RIZAP GROUP, Inc. (SPSE: 2928) uses debt in his business. But the real question is whether this debt makes the business risky.

When is debt dangerous?

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 costly) situation is where a company has to dilute its shareholders at a cheap share price just to get its debt under control. Of course, debt can be an important tool in businesses, especially capital intensive businesses. When we look at debt levels, we first look at cash and debt levels together.

Discover our latest analysis for RIZAP GROUP

What is the debt of RIZAP GROUP?

The image below, which you can click for more details, shows that RIZAP GROUP had a debt of JPY 36.8 billion at the end of December 2020, a reduction from JPY 105.5 billion over one year . On the other hand, he has 33.4 billion JP in cash, resulting in net debt of about 3.38 billion JP.

SPSE: 2928 History of debt to equity March 22, 2021

Is RIZAP GROUP’s balance sheet healthy?

According to the latest published balance sheet, RIZAP GROUP had debts of JP ¥ 75.6b due within 12 months, and debts of JP ¥ 58.1b due beyond 12 months. In compensation for these obligations, it had cash of JPY 33.4 billion as well as receivables valued at JP3.5 billion maturing within 12 months. It therefore has liabilities totaling JPY 76.8 billion more than its combined cash and short-term receivables.

This deficit is not so serious because RIZAP GROUP is worth 131.3 billion JP, and could therefore probably raise enough capital to consolidate its balance sheet, if the need arises. But it is clear that it is absolutely necessary to take a close look at whether it can manage its debt without 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). In this way, we consider both the absolute amount of debt, as well as the interest rates paid on it.

RIZAP GROUP has a very low debt / EBITDA ratio of 0.21, so it is strange to see low interest coverage as last year’s EBIT was only 2.4 times interest expense. So one way or another, it’s clear that debt levels are not trivial. Shareholders should know that RIZAP GROUP’s EBIT fell by 63% last year. If this decline continues, then it will be more difficult to pay off the debt than to sell foie gras at a vegan convention. The balance sheet is clearly the area you need to focus on when analyzing debt. But it is the results of RIZAP GROUP that will influence the balance sheet in the future. So if you want to know more about his earnings, it might be worth checking out this graph of his long-term profit trend.

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 this EBIT is supported by free cash flow. Over the past two years, RIZAP GROUP has actually generated more free cash flow than EBIT. This kind of strong cash generation warms our hearts like a puppy in a bumblebee costume.

Our point of view

While RIZAP GROUP’s EBIT growth rate makes us nervous. Its conversion of EBIT to free cash flow and of net debt to EBITDA were encouraging signs. We think RIZAP GROUP’s debt makes it a bit risky, after considering the aforementioned data points together. Not all risks are bad, as they can increase stock returns if they are profitable, but this risk of leverage is worth keeping in mind. 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. These risks can be difficult to spot. Every business has them, and we’ve spotted 3 warning signs for RIZAP GROUP (2 of which are of concern!) that you should know about.

If you are interested in investing in companies that can generate profits without the burden of debt, check out this page free list of growing companies that have net cash on the balance sheet.

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This Simply Wall St article is general in nature. It does not constitute a recommendation to buy or sell shares and does not take into account your goals or your financial situation. Our aim is to bring you long-term, targeted analysis based on fundamental data. Note that our analysis may not take into account the latest announcements from price sensitive companies or qualitative material. Simply Wall St has no position in the mentioned stocks.
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