We Think DYNAM JAPAN HOLDINGS (HKG:6889) Is Taking Some Risk With Its 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.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. We can see that DYNAM JAPAN HOLDINGS Co., Ltd. (HKG:6889) does use debt in its business. But the real question is whether this debt is making the company risky.

What Risk Does Debt Bring?

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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. 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. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

View 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 September 2020 DYNAM JAPAN HOLDINGS had JP¥35.2b of debt, an increase on JP¥4.64b, over one year. However, its balance sheet shows it holds JP¥67.8b in cash, so it actually has JP¥32.6b net cash.

How Strong Is DYNAM JAPAN HOLDINGS' Balance Sheet?

We can see from the most recent balance sheet that DYNAM JAPAN HOLDINGS had liabilities of JP¥62.7b falling due within a year, and liabilities of JP¥101.5b due beyond that. On the other hand, it had cash of JP¥67.8b and JP¥2.47b worth of receivables due within a year. So it has liabilities totalling JP¥93.9b more than its cash and near-term receivables, combined.

When you consider that this deficiency exceeds the company's JP¥82.3b market capitalization, you might well be inclined to review the balance sheet intently. In the scenario where the company had to clean up its balance sheet quickly, it seems likely shareholders would suffer extensive dilution. DYNAM JAPAN HOLDINGS boasts net cash, so it's fair to say it does not have a heavy debt load, even if it does have very significant liabilities, in total.

Shareholders should be aware that DYNAM JAPAN HOLDINGS's EBIT was down 65% last year. If that decline continues then paying off debt will be harder than selling foie gras at a vegan convention. There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since DYNAM JAPAN HOLDINGS will need earnings to service that debt. So if you're keen to discover more about its earnings, it might be worth checking out this graph of its long term earnings trend.

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. During the last three years, DYNAM JAPAN HOLDINGS generated free cash flow amounting to a very robust 97% of its EBIT, more than we'd expect. That puts it in a very strong position to pay down debt.

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¥32.6b. The cherry on top was that in converted 97% of that EBIT to free cash flow, bringing in JP¥7.8b. So while DYNAM JAPAN HOLDINGS does not have a great balance sheet, it's certainly not too bad. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. Case in point: We've spotted 3 warning signs for DYNAM JAPAN HOLDINGS 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.

If you decide to trade DYNAM JAPAN HOLDINGS, 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. 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.