Is Otani KogyoLtd (TSE:5939) A Risky Investment?

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. As with many other companies Otani Kogyo Co.,Ltd. (TSE:5939) makes use of debt. But is this debt a concern to shareholders?

When Is Debt Dangerous?

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 frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. 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 Otani KogyoLtd

How Much Debt Does Otani KogyoLtd Carry?

You can click the graphic below for the historical numbers, but it shows that as of December 2023 Otani KogyoLtd had JP¥548.0m of debt, an increase on JP¥48.0m, over one year. But it also has JP¥1.86b in cash to offset that, meaning it has JP¥1.32b net cash.

How Strong Is Otani KogyoLtd's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Otani KogyoLtd had liabilities of JP¥2.61b due within 12 months and liabilities of JP¥1.07b due beyond that. On the other hand, it had cash of JP¥1.86b and JP¥2.23b worth of receivables due within a year. So it actually has JP¥413.0m more liquid assets than total liabilities.

This surplus suggests that Otani KogyoLtd has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Succinctly put, Otani KogyoLtd boasts net cash, so it's fair to say it does not have a heavy debt load!

On top of that, Otani KogyoLtd grew its EBIT by 90% over the last twelve months, and that growth will make it easier to handle its debt. The balance sheet is clearly the area to focus on when you are analysing debt. But it is Otani KogyoLtd's earnings that will influence how the balance sheet holds up in the future. 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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. Otani KogyoLtd 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. Over the last three years, Otani KogyoLtd recorded negative free cash flow, in total. Debt is usually more expensive, and almost always more risky in the hands of a company with negative free cash flow. Shareholders ought to hope for an improvement.

Summing Up

While it is always sensible to investigate a company's debt, in this case Otani KogyoLtd has JP¥1.32b in net cash and a decent-looking balance sheet. And it impressed us with its EBIT growth of 90% over the last year. So we don't have any problem with Otani KogyoLtd's use of debt. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. To that end, you should learn about the 3 warning signs we've spotted with Otani KogyoLtd (including 2 which make us uncomfortable) .

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.

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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.