These 4 Measures Indicate That Oriental Consultants Holdings (TYO:2498) Is Using Debt Reasonably Well

David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the permanent loss of capital.' 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. We can see that Oriental Consultants Holdings Company Limited (TYO:2498) does use debt in its business. But is this debt a concern to shareholders?

When Is Debt A Problem?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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. 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.

Check out our latest analysis for Oriental Consultants Holdings

What Is Oriental Consultants Holdings's Net Debt?

As you can see below, Oriental Consultants Holdings had JP¥1.16b of debt at September 2020, down from JP¥2.55b a year prior. However, its balance sheet shows it holds JP¥8.12b in cash, so it actually has JP¥6.96b net cash.

How Healthy Is Oriental Consultants Holdings's Balance Sheet?

The latest balance sheet data shows that Oriental Consultants Holdings had liabilities of JP¥33.9b due within a year, and liabilities of JP¥1.85b falling due after that. Offsetting these obligations, it had cash of JP¥8.12b as well as receivables valued at JP¥11.1b due within 12 months. So it has liabilities totalling JP¥16.5b more than its cash and near-term receivables, combined.

Given this deficit is actually higher than the company's market capitalization of JP¥12.1b, 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. In the scenario where the company had to clean up its balance sheet quickly, it seems likely shareholders would suffer extensive dilution. 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.

And we also note warmly that Oriental Consultants Holdings grew its EBIT by 14% last year, making its debt load easier to handle. The balance sheet is clearly the area to focus on when you are analysing debt. But you can't view debt in total isolation; since Oriental Consultants 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 business needs free cash flow to pay off debt; accounting profits just don't cut it. 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 69% of its EBIT, about what we'd expect. This cold hard cash means it can reduce its debt when it wants to.

Summing up

Although Oriental Consultants 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¥6.96b. And it impressed us with free cash flow of JP¥4.1b, being 69% of its EBIT. So we are not troubled with Oriental Consultants Holdings's debt use. Over time, share prices tend to follow earnings per share, so if you're interested in Oriental Consultants Holdings, you may well want to click here to check an interactive graph of its earnings per share history.

When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.

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