The company's financial health as seen in the cash flow statements, and, once again, confirm the usefulness of debt and consider the pros and cons of fundraising — Mr. Hiroki Yanashita
Release date: 2020/09/17 10:47
Hello. I've already announced it on social media and blogs, but,
over two sessions next month (October) on the 17th and 31st, we will hold a valuation-creation seminar, as a basic and advanced course.
https://ameblo.jp/yukiyagi7/entry-12624899574.html
If you are available, please do participate.
This year, I’m also thinking of holding a trial study on TOC (Theory of Constraints),
and there may not be many people interested (laugh)…
Even though it’s a trial, I have to carefully consider the content…
and I’m thinking of doing it in a low-key way (laugh).
That said, this year has been incredibly busy, to say the least,
and the schedule is packed with little to no room, which is tough.
In the end, I think I’ll only be able to cover about half of the seminars I had planned,
so if you were looking forward to them, I apologize.
Now, after the previous salon lecture, there was a question about debt.
So first, although the data is somewhat old,
I have attached a table that classifies the cash flow statements of 2,971 listed companies into eight patterns.
The four patterns by business stage are also in my book (The Thorough Lecture on True Value Investing), but
here we are looking to pattern differences more by the company's strategic posture.
Patterns 1–3 are those with positive operating cash flow.
Pattern 1 has positive operating CF, while investing CF and financing CF are negative, accounting for more than half of the companies,
and cash increases through operating activities while cash is used for investing activities, so
"Profitable, proactive in future investments, and paying down debt with a healthy financial position"—a “good-type”
This can be said.
Pattern 2 has profitability and is raising funds for more aggressive investments than Pattern 1.
It can be called an "aggressive investment type".
Pattern 3 shows profitability, but conservative on investment and improving financial strength through asset sales, etc.
Thus it's seen as a "restructuring type".
On the other hand, patterns 4–6 have negative operating CF. In other words, their core business is weak.
Pattern 4 is a "risk-taking type" that raises funds to allocate to capital expenditures to turn around the business slump,
Pattern 5 is a "structural reform or divestment type" that raises funds for investments via asset sales to address the downturn.
That's right.
Pattern 6 is also weak in business, with continuing cash outflow, no investments, and no financing either,
a "dead-end" situation perhaps.
Pattern 7 is in a similar condition to 6, yet it manages to secure financing,
is this because the sources of funding have high expectations for the future, or are they misjudging it?
Pattern 8 is a special type. They generate earnings from core business but do not invest, yet they are raising funds,
perhaps laying the groundwork for the future, or…
These are merely formal categorizations, and there are of course exceptions.
They are a guidepost to understanding the characteristics of the analyzed companies from the cash-flow perspective.
Now, about the question mentioned above, it's concerning financing for Kachitas (8919).
As attached, the company uses a commitment line.
A commitment line is an arrangement between a company and a bank that sets a limit in advance,
and you can borrow and repay freely up to that limit.
There is also an overdraft in a similar contract, but this one is collateralized.
In exchange for providing collateral,
a high fee (commitment fee) is charged at the outset of the contract.
Using the commitment line eliminates the need for extra cash on hand,
and by paying down interest-bearing debt, the balance sheet can be slimmed,
increase equity and/or reduce interest burden as well.
On the other hand, for companies that do not need funds regularly,
the commitment fee applies even if the credit line is not used,
and may result in higher costs.
Kachitas, of course, is constantly acquiring properties and is in a state where demand cannot keep up,
and plans to double the number of deals it handles in the future.
That means funding needs will grow for items such as home renovation equipment and materials.
Therefore, it is necessary to maintain a system that can procure funds flexibly and quickly.
What the questioner asked was about lump-sum repayment,
basically the amount of interest-bearing debt deducted in the DCF is the entire current outstanding debt,
whether it is a lump sum or installments, it does not affect the annual changes in the company value.
Repayment of borrowings is not an expense, so it is not recorded on the P/L. It reduces liabilities, changing the balance sheet.
Only interest payments are recorded as non-operating expenses.
Actual debt repayments are reflected in the financing cash flows of the cash flow statement.
Incidentally, Kachitas basically refinances the lump-sum repayments,
and reorganizes by finely balancing borrowings and repayments, so you don't need to worry about this area.
Moreover, this commitment line is structured as a syndicated loan among multiple banks, so the banks share the risk when lending.
As I've long argued, Japanese companies are too fixated on being debt-free and neglect opportunity costs,
and in Japan there are many so-called practically debt-free companies that hold cash greater than their interest-bearing liabilities, in addition to those with no interest-bearing liabilities at all.
Of course, management should keep a certain amount of working capital on hand at all times.
Also, to prepare for Lehman shock and major disasters, and especially in this COVID-19 shock,
there's a sense that claims such as "Japan's management model with generous internal reserves is being reevaluated" are getting ahead of themselves,
but no, wait a moment.
Is it reasonable to go out on a sunny day with full protection against typhoons, floods, lightning, earthquakes, fires, and viruses? It is obvious that a company whose ability to seize opportunities is eroded and whose resilience is weakened would face far higher risk when confronted with such shocks.
Obviously, the ability to decide and act in a timely manner in response to changing circumstances is more important, both in the organization and in the management mindset.
Additionally, companies considering M&A need to secure funds for acquisitions when good sellers appear,
and hoarding cash as an excuse may lead to postponing investments for future growth.
In fact, there are companies that have been saying for years, "We keep cash on hand to be able to do M&A as soon as a good deal appears,"
and during that time, not a single large M&A has been executed.
Thus, it is important to effectively use leverage as a low-cost financing method in management; however, when there is no debt, shareholders face only business risk, so adding debt (leverage) increases the volatility of FCF and, in effect, means that times are very good when things are good, and very bad when things go wrong.
Therefore, for companies with relatively small earnings variability, using capital leverage to enhance shareholders' risk-return is reasonable, while for companies with relatively large earnings variability, it's necessary to restrain capital leverage to avoid overstating risk-return, as I have told you.
What we should consider here is that, as shown by the current COVID-19 pandemic, the service industry is vulnerable to sudden drops in demand. And the speed of demand recovery is certainly slow.
When the pandemic subsides and demand returns to normal in the real economy, demand will rebound in a V shape; however, even after the downturn ends, service demand will not rebound in a V shape. Services have a characteristic of simultaneity (real-time nature), and because they charge based on occupancy time, they cannot be stored as inventory.
In such industries, excessive leverage is high risk.
So, have you understood that the ability to secure financing is a key measure of managerial skill?
Well, that is all for today.
