We Think HIRAYAMA HOLDINGSLtd (TYO:7781) Can Manage Its Debt With Ease

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 can see that HIRAYAMA HOLDINGS Co.,Ltd. (TYO:7781) does use debt in its business. But should shareholders be worried about its use of debt?

When Is Debt A Problem?

Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. 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. 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. When we examine debt levels, we first consider both cash and debt levels, together.

Check out our latest analysis for HIRAYAMA HOLDINGSLtd

What Is HIRAYAMA HOLDINGSLtd's Debt?

The image below, which you can click on for greater detail, shows that HIRAYAMA HOLDINGSLtd had debt of JP¥720.0m at the end of December 2020, a reduction from JP¥1.03b over a year. However, its balance sheet shows it holds JP¥3.86b in cash, so it actually has JP¥3.14b net cash.

How Strong Is HIRAYAMA HOLDINGSLtd's Balance Sheet?

The latest balance sheet data shows that HIRAYAMA HOLDINGSLtd had liabilities of JP¥3.40b due within a year, and liabilities of JP¥1.37b falling due after that. Offsetting these obligations, it had cash of JP¥3.86b as well as receivables valued at JP¥2.43b due within 12 months. So it can boast JP¥1.51b more liquid assets than total liabilities.

This surplus strongly suggests that HIRAYAMA HOLDINGSLtd has a rock-solid balance sheet (and the debt is of no concern whatsoever). On this view, lenders should feel as safe as the beloved of a black-belt karate master. Simply put, the fact that HIRAYAMA HOLDINGSLtd has more cash than debt is arguably a good indication that it can manage its debt safely.

On the other hand, HIRAYAMA HOLDINGSLtd's EBIT dived 14%, over the last year. If that rate of decline in earnings continues, the company could find itself in a tight spot. The balance sheet is clearly the area to focus on when you are analysing debt. But it is HIRAYAMA 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.

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 generation warms our hearts like a puppy in a bumblebee suit.

Summing up

While it is always sensible to investigate a company's debt, in this case HIRAYAMA HOLDINGSLtd has JP¥3.14b in net cash and a decent-looking balance sheet. The cherry on top was that in converted 193% of that EBIT to free cash flow, bringing in JP¥822m. So we don't think HIRAYAMA HOLDINGSLtd's use of debt is risky. 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. For instance, we've identified 3 warning signs for HIRAYAMA HOLDINGSLtd that 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. 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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