Is Tokyo Chuo Auction Holdings (HKG:1939) Using Debt Sensibly?

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 seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. Importantly, Tokyo Chuo Auction Holdings Limited (HKG:1939) does carry debt. But should shareholders be worried about its use of debt?

Why Does Debt Bring Risk?

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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. The first step when considering a company's debt levels is to consider its cash and debt together.

See our latest analysis for Tokyo Chuo Auction Holdings

What Is Tokyo Chuo Auction Holdings's Debt?

The image below, which you can click on for greater detail, shows that at September 2020 Tokyo Chuo Auction Holdings had debt of HK$58.8m, up from HK$38.5m in one year. However, it does have HK$153.2m in cash offsetting this, leading to net cash of HK$94.3m.

How Strong Is Tokyo Chuo Auction Holdings' Balance Sheet?

We can see from the most recent balance sheet that Tokyo Chuo Auction Holdings had liabilities of HK$181.3m falling due within a year, and liabilities of HK$52.3m due beyond that. Offsetting these obligations, it had cash of HK$153.2m as well as receivables valued at HK$211.8m due within 12 months. So it actually has HK$131.3m more liquid assets than total liabilities.

This excess liquidity is a great indication that Tokyo Chuo Auction Holdings' balance sheet is almost as strong as Fort Knox. With this in mind one could posit that its balance sheet means the company is able to handle some adversity. Succinctly put, Tokyo Chuo Auction Holdings boasts net cash, so it's fair to say it does not have a heavy debt load! There's no doubt that we learn most about debt from the balance sheet. But it is Tokyo Chuo Auction Holdings's earnings that will influence how the balance sheet holds up in the future. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

In the last year Tokyo Chuo Auction Holdings had a loss before interest and tax, and actually shrunk its revenue by 67%, to HK$57m. That makes us nervous, to say the least.

So How Risky Is Tokyo Chuo Auction Holdings?

We have no doubt that loss making companies are, in general, riskier than profitable ones. And in the last year Tokyo Chuo Auction Holdings had an earnings before interest and tax (EBIT) loss, truth be told. And over the same period it saw negative free cash outflow of HK$49m and booked a HK$2.8m accounting loss. With only HK$94.3m on the balance sheet, it would appear that its going to need to raise capital again soon. Overall, its balance sheet doesn't seem overly risky, at the moment, but we're always cautious until we see the positive free cash flow. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. For instance, we've identified 4 warning signs for Tokyo Chuo Auction Holdings (1 is a bit concerning) you should be aware of.

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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