Is HIRAYAMA HOLDINGSLtd (TYO:7781) Using Too Much Debt?

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. We note that HIRAYAMA HOLDINGS Co.,Ltd. (TYO:7781) does have debt on its balance sheet. But the real question is whether this debt is making the company risky.

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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. When we think about a company's use of debt, we first look at cash and debt together.

Check out our latest analysis for HIRAYAMA HOLDINGSLtd

How Much Debt Does HIRAYAMA HOLDINGSLtd Carry?

As you can see below, HIRAYAMA HOLDINGSLtd had JP¥807.0m of debt at September 2020, down from JP¥1.12b a year prior. But on the other hand it also has JP¥3.53b in cash, leading to a JP¥2.73b net cash position.

How Strong Is HIRAYAMA HOLDINGSLtd's Balance Sheet?

According to the last reported balance sheet, HIRAYAMA HOLDINGSLtd had liabilities of JP¥2.99b due within 12 months, and liabilities of JP¥1.44b due beyond 12 months. Offsetting these obligations, it had cash of JP¥3.53b as well as receivables valued at JP¥2.37b due within 12 months. So it can boast JP¥1.47b more liquid assets than total liabilities.

This surplus liquidity suggests that HIRAYAMA HOLDINGSLtd's balance sheet could take a hit just as well as Homer Simpson's head can take a punch. With this in mind one could posit that its balance sheet is as strong as beautiful a rare rhino. Simply put, the fact that HIRAYAMA HOLDINGSLtd has more cash than debt is arguably a good indication that it can manage its debt safely.

HIRAYAMA HOLDINGSLtd's EBIT was pretty flat over the last year, but that shouldn't be an issue given the it doesn't have a lot of debt. The balance sheet is clearly the area to focus on when you are analysing debt. But you can't view debt in total isolation; since HIRAYAMA HOLDINGSLtd 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.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. While HIRAYAMA HOLDINGSLtd has net cash on its balance sheet, it's still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. Over the last three years, HIRAYAMA HOLDINGSLtd actually produced more free cash flow than EBIT. That sort of strong cash conversion gets us as excited as the crowd when the beat drops at a Daft Punk concert.

Summing up

While we empathize with investors who find debt concerning, you should keep in mind that HIRAYAMA HOLDINGSLtd has net cash of JP¥2.73b, as well as more liquid assets than liabilities. The cherry on top was that in converted 180% of that EBIT to free cash flow, bringing in JP¥468m. So is HIRAYAMA HOLDINGSLtd's debt a risk? It doesn't seem so to us. 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. Case in point: We've spotted 3 warning signs for HIRAYAMA HOLDINGSLtd you should be aware of.

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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