Does O-Well (TSE:7670) Have A Healthy Balance Sheet?

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.' 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. Importantly, O-Well Corporation (TSE:7670) does carry debt. But the more important question is: how much risk is that debt creating?

When Is Debt Dangerous?

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. The first step when considering a company's debt levels is to consider its cash and debt together.

See our latest analysis for O-Well

What Is O-Well's Debt?

You can click the graphic below for the historical numbers, but it shows that O-Well had JP¥4.04b of debt in September 2024, down from JP¥4.44b, one year before. But it also has JP¥5.40b in cash to offset that, meaning it has JP¥1.35b net cash.

How Healthy Is O-Well's Balance Sheet?

The latest balance sheet data shows that O-Well had liabilities of JP¥19.9b due within a year, and liabilities of JP¥4.59b falling due after that. Offsetting this, it had JP¥5.40b in cash and JP¥16.7b in receivables that were due within 12 months. So its liabilities total JP¥2.38b more than the combination of its cash and short-term receivables.

While this might seem like a lot, it is not so bad since O-Well has a market capitalization of JP¥10.3b, and so it could probably strengthen its balance sheet by raising capital if it needed to. However, it is still worthwhile taking a close look at its ability to pay off debt. While it does have liabilities worth noting, O-Well also has more cash than debt, so we're pretty confident it can manage its debt safely.

The good news is that O-Well has increased its EBIT by 2.9% over twelve months, which should ease any concerns about debt repayment. When analysing debt levels, the balance sheet is the obvious place to start. But it is O-Well'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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. O-Well 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. In the last three years, O-Well's free cash flow amounted to 36% of its EBIT, less than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.

Summing Up

While O-Well does have more liabilities than liquid assets, it also has net cash of JP¥1.35b. And it also grew its EBIT by 2.9% over the last year. So we don't have any problem with O-Well's use of debt. 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 O-Well you should be aware of.

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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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.