Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk.' So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. Importantly, DEPPON LOGISTICS Co.,LTD. (SHSE:603056) does carry debt. But should shareholders be worried about its use of debt?

When Is Debt A Problem?

Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. If things get really bad, the lenders can take control of the business. 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. Of course, plenty of companies use debt to fund growth, without any negative consequences. The first step when considering a company's debt levels is to consider its cash and debt together.

See our latest analysis for DEPPON LOGISTICSLTD

What Is DEPPON LOGISTICSLTD's Net Debt?

The image below, which you can click on for greater detail, shows that DEPPON LOGISTICSLTD had debt of CN¥2.47b at the end of March 2023, a reduction from CN¥4.21b over a year. However, it does have CN¥1.92b in cash offsetting this, leading to net debt of about CN¥553.3m.

How Healthy Is DEPPON LOGISTICSLTD's Balance Sheet?

The latest balance sheet data shows that DEPPON LOGISTICSLTD had liabilities of CN¥6.12b due within a year, and liabilities of CN¥1.29b falling due after that. On the other hand, it had cash of CN¥1.92b and CN¥2.34b worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by CN¥3.16b.

Of course, DEPPON LOGISTICSLTD has a market capitalization of CN¥17.1b, so these liabilities are probably manageable. Having said that, it's clear that we should continue to monitor its balance sheet, lest it change for the worse.

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.

DEPPON LOGISTICSLTD has a low net debt to EBITDA ratio of only 0.30. And its EBIT easily covers its interest expense, being 13.6 times the size. So you could argue it is no more threatened by its debt than an elephant is by a mouse. Although DEPPON LOGISTICSLTD made a loss at the EBIT level, last year, it was also good to see that it generated CN¥671m in EBIT over the last twelve months. There's no doubt that we learn most about debt from the balance sheet. But ultimately the future profitability of the business will decide if DEPPON LOGISTICSLTD 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.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So it is important to check how much of its earnings before interest and tax (EBIT) converts to actual free cash flow. Over the last year, DEPPON LOGISTICSLTD actually produced more free cash flow than EBIT. That sort of strong cash generation warms our hearts like a puppy in a bumblebee suit.

Our View

Happily, DEPPON LOGISTICSLTD's impressive interest cover implies it has the upper hand on its debt. And that's just the beginning of the good news since its conversion of EBIT to free cash flow is also very heartening. Zooming out, DEPPON LOGISTICSLTD seems to use debt quite reasonably; and that gets the nod from us. After all, sensible leverage can boost returns on equity. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. We've identified 1 warning sign with DEPPON LOGISTICSLTD , and understanding them should be part of your investment process.

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.