Is HIRAYAMA HOLDINGSLtd (TSE:7781) A Risky Investment?

Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' 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. Importantly, HIRAYAMA HOLDINGS Co.,Ltd. (TSE:7781) does carry debt. But is this debt a concern to shareholders?

When Is Debt Dangerous?

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. 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. Of course, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. When we examine debt levels, we first consider both cash and debt levels, together.

View our latest analysis for HIRAYAMA HOLDINGSLtd

What Is HIRAYAMA HOLDINGSLtd's Net Debt?

You can click the graphic below for the historical numbers, but it shows that HIRAYAMA HOLDINGSLtd had JP¥729.0m of debt in December 2023, down from JP¥1.01b, one year before. But on the other hand it also has JP¥4.70b in cash, leading to a JP¥3.97b net cash position.

How Strong Is HIRAYAMA HOLDINGSLtd's Balance Sheet?

The latest balance sheet data shows that HIRAYAMA HOLDINGSLtd had liabilities of JP¥4.69b due within a year, and liabilities of JP¥2.09b falling due after that. Offsetting these obligations, it had cash of JP¥4.70b as well as receivables valued at JP¥4.15b due within 12 months. So it actually has JP¥2.07b more liquid assets than total liabilities.

This excess liquidity suggests that HIRAYAMA HOLDINGSLtd is taking a careful approach to debt. Because it has plenty of assets, it is unlikely to have trouble with its lenders. Simply put, the fact that HIRAYAMA HOLDINGSLtd has more cash than debt is arguably a good indication that it can manage its debt safely.

And we also note warmly that HIRAYAMA HOLDINGSLtd grew its EBIT by 11% last year, making its debt load easier to handle. When analysing debt levels, the balance sheet is the obvious place to start. But it is HIRAYAMA HOLDINGSLtd'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. 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 most recent three years, HIRAYAMA HOLDINGSLtd recorded free cash flow worth 54% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This cold hard cash means it can reduce its debt when it wants to.

Summing Up

While we empathize with investors who find debt concerning, you should keep in mind that HIRAYAMA HOLDINGSLtd has net cash of JP¥3.97b, as well as more liquid assets than liabilities. And it also grew its EBIT by 11% over the last year. So is HIRAYAMA HOLDINGSLtd's debt a risk? It doesn't seem so to us. 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. We've identified 2 warning signs with HIRAYAMA HOLDINGSLtd , and understanding them should be part of your investment process.

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.