DYNAM JAPAN HOLDINGS (HKG:6889) Takes On Some Risk With Its Use Of Debt

Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. We note that DYNAM JAPAN HOLDINGS Co., Ltd. (HKG:6889) does have debt on its balance sheet. But should shareholders be worried about its use of debt?

When Is Debt Dangerous?

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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. 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.

Check out our latest analysis for DYNAM JAPAN HOLDINGS

What Is DYNAM JAPAN HOLDINGS's Debt?

You can click the graphic below for the historical numbers, but it shows that as of March 2021 DYNAM JAPAN HOLDINGS had JP¥34.0b of debt, an increase on JP¥13.2b, over one year. However, its balance sheet shows it holds JP¥74.7b in cash, so it actually has JP¥40.7b net cash.

How Strong Is DYNAM JAPAN HOLDINGS' Balance Sheet?

Zooming in on the latest balance sheet data, we can see that DYNAM JAPAN HOLDINGS had liabilities of JP¥59.8b due within 12 months and liabilities of JP¥109.3b due beyond that. On the other hand, it had cash of JP¥74.7b and JP¥6.76b worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by JP¥87.7b.

Given this deficit is actually higher than the company's market capitalization of JP¥78.1b, we think shareholders really should watch DYNAM JAPAN HOLDINGS's debt levels, like a parent watching their child ride a bike for the first time. In the scenario where the company had to clean up its balance sheet quickly, it seems likely shareholders would suffer extensive dilution. Given that DYNAM JAPAN 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.

Importantly, DYNAM JAPAN HOLDINGS's EBIT fell a jaw-dropping 94% in the last twelve months. If that decline continues then paying off debt will be harder than selling foie gras at a vegan convention. When analysing debt levels, the balance sheet is the obvious place to start. But it is DYNAM JAPAN 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.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. DYNAM JAPAN 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, DYNAM JAPAN HOLDINGS actually produced more free cash flow than EBIT over the last three years. That sort of strong cash generation warms our hearts like a puppy in a bumblebee suit.

Summing up

Although DYNAM JAPAN HOLDINGS's balance sheet isn't particularly strong, due to the total liabilities, it is clearly positive to see that it has net cash of JP¥40.7b. The cherry on top was that in converted 120% of that EBIT to free cash flow, bringing in JP¥27b. Despite its cash we think that DYNAM JAPAN HOLDINGS seems to struggle to grow its EBIT, so we are wary of 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 example, we've discovered 4 warning signs for DYNAM JAPAN HOLDINGS (1 is concerning!) that you should be aware of before investing here.

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.

If you're looking for stocks to buy, use the lowest-cost* platform that is rated #1 Overall by Barron’s, Interactive Brokers. Trade stocks, options, futures, forex, bonds and funds on 135 markets, all from a single integrated account. Promoted

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.
^*Interactive Brokers Rated Lowest Cost Broker by StockBrokers.com Annual Online Review 2020

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.