Does Amita HoldingsLtd (TYO:2195) Have A Healthy Balance Sheet?

The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. We can see that Amita Holdings Co.,Ltd. (TYO:2195) does use debt in its business. 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. If things get really bad, the lenders can take control of the business. 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, debt can be an important tool in businesses, particularly capital heavy businesses. The first step when considering a company's debt levels is to consider its cash and debt together.

Check out our latest analysis for Amita HoldingsLtd

How Much Debt Does Amita HoldingsLtd Carry?

The image below, which you can click on for greater detail, shows that at December 2020 Amita HoldingsLtd had debt of JP¥1.90b, up from JP¥1.70b in one year. However, it does have JP¥1.24b in cash offsetting this, leading to net debt of about JP¥665.0m.

How Strong Is Amita HoldingsLtd's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Amita HoldingsLtd had liabilities of JP¥1.67b due within 12 months and liabilities of JP¥1.84b due beyond that. Offsetting this, it had JP¥1.24b in cash and JP¥691.0m in receivables that were due within 12 months. So its liabilities total JP¥1.58b more than the combination of its cash and short-term receivables.

Amita HoldingsLtd has a market capitalization of JP¥3.55b, so it could very likely raise cash to ameliorate its balance sheet, if the need arose. However, it is still worthwhile taking a close look at its ability to pay off debt.

We use two main ratios to inform us about debt levels relative to earnings. The first is net debt divided by earnings before interest, tax, depreciation, and amortization (EBITDA), while the second is how many times its earnings before interest and tax (EBIT) covers its interest expense (or its interest cover, for short). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

Amita HoldingsLtd's net debt is only 1.5 times its EBITDA. And its EBIT easily covers its interest expense, being 17.1 times the size. So you could argue it is no more threatened by its debt than an elephant is by a mouse. Also positive, Amita HoldingsLtd grew its EBIT by 22% in the last year, and that should make it easier to pay down debt, going forward. When analysing debt levels, the balance sheet is the obvious place to start. But it is Amita HoldingsLtd'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. So it's worth checking how much of that EBIT is backed by free cash flow. Happily for any shareholders, Amita HoldingsLtd actually produced more free cash flow than EBIT over the last three years. That sort of strong cash conversion gets us as excited as the crowd when the beat drops at a Daft Punk concert.

Our View

Happily, Amita HoldingsLtd's impressive interest cover implies it has the upper hand on its debt. But truth be told we feel its level of total liabilities does undermine this impression a bit. Zooming out, Amita HoldingsLtd seems to use debt quite reasonably; and that gets the nod from us. While debt does bring risk, when used wisely it can also bring a higher return on equity. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. For example - Amita HoldingsLtd has 2 warning signs we think you should be aware of.

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. 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.
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