Here's Why Oriental Consultants Holdings (TYO:2498) Can Manage Its Debt Responsibly

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 Oriental Consultants Holdings Company Limited (TYO:2498) does use debt in its business. But the more important question is: how much risk is that debt creating?

What Risk Does Debt Bring?

Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. 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 thing to do when considering how much debt a business uses is to look at its cash and debt together.

See our latest analysis for Oriental Consultants Holdings

What Is Oriental Consultants Holdings's Net Debt?

The image below, which you can click on for greater detail, shows that Oriental Consultants Holdings had debt of JP¥7.45b at the end of December 2020, a reduction from JP¥9.44b over a year. However, its balance sheet shows it holds JP¥10.0b in cash, so it actually has JP¥2.60b net cash.

How Healthy Is Oriental Consultants Holdings' Balance Sheet?

According to the last reported balance sheet, Oriental Consultants Holdings had liabilities of JP¥37.6b due within 12 months, and liabilities of JP¥1.80b due beyond 12 months. Offsetting this, it had JP¥10.0b in cash and JP¥9.67b in receivables that were due within 12 months. So its liabilities total JP¥19.7b more than the combination of its cash and short-term receivables.

Given this deficit is actually higher than the company's market capitalization of JP¥14.6b, we think shareholders really should watch Oriental Consultants Holdings's debt levels, like a parent watching their child ride a bike for the first time. Hypothetically, extremely heavy dilution would be required if the company were forced to pay down its liabilities by raising capital at the current share price. Oriental Consultants 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.

Also good is that Oriental Consultants Holdings grew its EBIT at 17% over the last year, further increasing its ability to manage debt. When analysing debt levels, the balance sheet is the obvious place to start. But it is Oriental Consultants 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. Oriental Consultants 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, Oriental Consultants Holdings produced sturdy free cash flow equating to 58% of its EBIT, about what we'd expect. This free cash flow puts the company in a good position to pay down debt, when appropriate.

Summing up

While Oriental Consultants Holdings does have more liabilities than liquid assets, it also has net cash of JP¥2.60b. And it impressed us with its EBIT growth of 17% over the last year. So we are not troubled with Oriental Consultants Holdings's debt use. 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. To that end, you should be aware of the 2 warning signs we've spotted with Oriental Consultants Holdings .

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

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