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 &Do Holdings Co.,Ltd. (TSE:3457) does have debt on its balance sheet. But the more important question is: how much risk is that debt creating?
Why Does Debt Bring Risk?
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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. Of course, plenty of companies use debt to fund growth, without any negative consequences. The first step when considering a company's debt levels is to consider its cash and debt together.
View our latest analysis for &Do HoldingsLtd
What Is &Do HoldingsLtd's Debt?
You can click the graphic below for the historical numbers, but it shows that as of March 2024 &Do HoldingsLtd had JP¥55.9b of debt, an increase on JP¥51.0b, over one year. However, it also had JP¥8.45b in cash, and so its net debt is JP¥47.4b.
How Healthy Is &Do HoldingsLtd's Balance Sheet?
The latest balance sheet data shows that &Do HoldingsLtd had liabilities of JP¥31.0b due within a year, and liabilities of JP¥31.6b falling due after that. Offsetting these obligations, it had cash of JP¥8.45b as well as receivables valued at JP¥2.08b due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by JP¥52.1b.
The deficiency here weighs heavily on the JP¥16.9b company itself, as if a child were struggling under the weight of an enormous back-pack full of books, his sports gear, and a trumpet. So we definitely think shareholders need to watch this one closely. After all, &Do HoldingsLtd would likely require a major re-capitalisation if it had to pay its creditors today.
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). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.
As it happens &Do HoldingsLtd has a fairly concerning net debt to EBITDA ratio of 11.5 but very strong interest coverage of 25.5. This means that unless the company has access to very cheap debt, that interest expense will likely grow in the future. Sadly, &Do HoldingsLtd's EBIT actually dropped 7.4% in the last year. If that earnings trend continues then its debt load will grow heavy like the heart of a polar bear watching its sole cub. There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since &Do HoldingsLtd will need earnings to service that debt. 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. So it's worth checking how much of that EBIT is backed by free cash flow. Over the last three years, &Do HoldingsLtd saw substantial negative free cash flow, in total. While investors are no doubt expecting a reversal of that situation in due course, it clearly does mean its use of debt is more risky.
Our View
On the face of it, &Do HoldingsLtd's conversion of EBIT to free cash flow left us tentative about the stock, and its level of total liabilities was no more enticing than the one empty restaurant on the busiest night of the year. But on the bright side, its interest cover is a good sign, and makes us more optimistic. After considering the datapoints discussed, we think &Do HoldingsLtd has too much debt. While some investors love that sort of risky play, it's certainly not our cup of tea. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. For instance, we've identified 3 warning signs for &Do HoldingsLtd (1 is concerning) you should be aware of.
Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.
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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.
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About TSE:3457
Slight with mediocre balance sheet.
