Hoden Seimitsu Kako Kenkyusho (TYO:6469) Has Debt But No Earnings; Should You Worry?

Warren Buffett famously said, '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. We note that Hoden Seimitsu Kako Kenkyusho Co., Ltd. (TYO:6469) does have debt on its balance sheet. But should shareholders be worried about its use of debt?

When Is Debt A Problem?

Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. If things get really bad, the lenders can take control of the business. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. 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 step when considering a company's debt levels is to consider its cash and debt together.

View our latest analysis for Hoden Seimitsu Kako Kenkyusho

What Is Hoden Seimitsu Kako Kenkyusho's Debt?

As you can see below, at the end of May 2020, Hoden Seimitsu Kako Kenkyusho had JP¥6.32b of debt, up from JP¥4.63b a year ago. Click the image for more detail. However, it does have JP¥2.11b in cash offsetting this, leading to net debt of about JP¥4.21b.

How Healthy Is Hoden Seimitsu Kako Kenkyusho's Balance Sheet?

According to the last reported balance sheet, Hoden Seimitsu Kako Kenkyusho had liabilities of JP¥5.15b due within 12 months, and liabilities of JP¥5.67b due beyond 12 months. Offsetting these obligations, it had cash of JP¥2.11b as well as receivables valued at JP¥2.78b due within 12 months. So its liabilities total JP¥5.92b more than the combination of its cash and short-term receivables.

This deficit casts a shadow over the JP¥3.77b company, like a colossus towering over mere mortals. So we'd watch its balance sheet closely, without a doubt. After all, Hoden Seimitsu Kako Kenkyusho would likely require a major re-capitalisation if it had to pay its creditors today. There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since Hoden Seimitsu Kako Kenkyusho will need earnings to service that debt. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

Over 12 months, Hoden Seimitsu Kako Kenkyusho made a loss at the EBIT level, and saw its revenue drop to JP¥11b, which is a fall of 3.0%. We would much prefer see growth.

Caveat Emptor

Importantly, Hoden Seimitsu Kako Kenkyusho had an earnings before interest and tax (EBIT) loss over the last year. To be specific the EBIT loss came in at JP¥300m. When we look at that alongside the significant liabilities, we're not particularly confident about the company. It would need to improve its operations quickly for us to be interested in it. For example, we would not want to see a repeat of last year's loss of JP¥344m. In the meantime, we consider the stock to be risky. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. To that end, you should learn about the 3 warning signs we've spotted with Hoden Seimitsu Kako Kenkyusho (including 1 which is doesn't sit too well with us) .

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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