Plaza Create HonshaLtd (TYO:7502) Has A Pretty Healthy Balance Sheet

Warren Buffett famously said, 'Volatility is far from synonymous with risk.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. We note that Plaza Create Honsha Co.,Ltd. (TYO:7502) does have debt on its balance sheet. But should shareholders be worried about its use of debt?

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. 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.

See our latest analysis for Plaza Create HonshaLtd

What Is Plaza Create HonshaLtd's Net Debt?

You can click the graphic below for the historical numbers, but it shows that Plaza Create HonshaLtd had JP¥7.46b of debt in December 2020, down from JP¥7.93b, one year before. However, it does have JP¥1.96b in cash offsetting this, leading to net debt of about JP¥5.50b.

A Look At Plaza Create HonshaLtd's Liabilities

According to the last reported balance sheet, Plaza Create HonshaLtd had liabilities of JP¥7.30b due within 12 months, and liabilities of JP¥4.20b due beyond 12 months. Offsetting this, it had JP¥1.96b in cash and JP¥2.18b in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by JP¥7.36b.

Given this deficit is actually higher than the company's market capitalization of JP¥5.43b, we think shareholders really should watch Plaza Create HonshaLtd'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.

We measure a company's debt load relative to its earnings power by looking at its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and by calculating how easily its earnings before interest and tax (EBIT) cover its interest expense (interest cover). The advantage of this approach is that we take into account both the absolute quantum of debt (with net debt to EBITDA) and the actual interest expenses associated with that debt (with its interest cover ratio).

Plaza Create HonshaLtd has a debt to EBITDA ratio of 4.4 and its EBIT covered its interest expense 6.5 times. Taken together this implies that, while we wouldn't want to see debt levels rise, we think it can handle its current leverage. Notably, Plaza Create HonshaLtd's EBIT launched higher than Elon Musk, gaining a whopping 392% on last year. There's no doubt that we learn most about debt from the balance sheet. But it is Plaza Create HonshaLtd'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.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. Happily for any shareholders, Plaza Create HonshaLtd actually produced more free cash flow than EBIT over the last three years. That sort of strong cash generation warms our hearts like a puppy in a bumblebee suit.

Our View

Plaza Create HonshaLtd's conversion of EBIT to free cash flow was a real positive on this analysis, as was its EBIT growth rate. But truth be told its level of total liabilities had us nibbling our nails. Looking at all this data makes us feel a little cautious about Plaza Create HonshaLtd's debt levels. While debt does have its upside in higher potential returns, we think shareholders should definitely consider how debt levels might make the stock more risky. 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. These risks can be hard to spot. Every company has them, and we've spotted 4 warning signs for Plaza Create HonshaLtd (of which 1 is potentially serious!) you should know about.

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

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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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