Does Niraku GC Holdings (HKG:1245) Have A Healthy Balance Sheet?

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. We can see that Niraku GC Holdings, Inc. (HKG:1245) does use debt in its business. But the more important question is: how much risk is that debt creating?

When Is Debt A Problem?

Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. If things get really bad, the lenders can take control of the business. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. When we examine debt levels, we first consider both cash and debt levels, together.

View our latest analysis for Niraku GC Holdings

What Is Niraku GC Holdings's Net Debt?

As you can see below, Niraku GC Holdings had JP¥11.7b of debt at March 2022, down from JP¥16.7b a year prior. But on the other hand it also has JP¥11.8b in cash, leading to a JP¥146.0m net cash position.

How Strong Is Niraku GC Holdings' Balance Sheet?

According to the last reported balance sheet, Niraku GC Holdings had liabilities of JP¥12.0b due within 12 months, and liabilities of JP¥37.3b due beyond 12 months. Offsetting these obligations, it had cash of JP¥11.8b as well as receivables valued at JP¥136.0m due within 12 months. So its liabilities total JP¥37.3b more than the combination of its cash and short-term receivables.

This deficit casts a shadow over the JP¥4.62b company, like a colossus towering over mere mortals. So we definitely think shareholders need to watch this one closely. At the end of the day, Niraku GC Holdings would probably need a major re-capitalization if its creditors were to demand repayment. Given that Niraku GC Holdings has more cash than debt, we're pretty confident it can handle its debt, despite the fact that it has a lot of liabilities in total.

Notably, Niraku GC Holdings made a loss at the EBIT level, last year, but improved that to positive EBIT of JP¥1.3b in the last twelve months. There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since Niraku GC Holdings will need earnings to service that debt. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. Niraku GC Holdings may have net cash on the balance sheet, but it is still interesting to look at how well the business converts its earnings before interest and tax (EBIT) to free cash flow, because that will influence both its need for, and its capacity to manage debt. Happily for any shareholders, Niraku GC Holdings actually produced more free cash flow than EBIT over the last year. There's nothing better than incoming cash when it comes to staying in your lenders' good graces.

Summing Up

While Niraku GC Holdings does have more liabilities than liquid assets, it also has net cash of JP¥146.0m. And it impressed us with free cash flow of JP¥4.7b, being 362% of its EBIT. Despite the cash, we do find Niraku GC Holdings's level of total liabilities concerning, so we're not particularly comfortable with the stock. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. For instance, we've identified 3 warning signs for Niraku GC Holdings (1 is significant) you should be aware of.

At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.

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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.