Here's Why Medical Ikkou GroupLtd (TYO:3353) Has A Meaningful Debt Burden

Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' 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. As with many other companies Medical Ikkou Group Co.,Ltd. (TYO:3353) makes use of debt. But is this debt a concern to shareholders?

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. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. The first step when considering a company's debt levels is to consider its cash and debt together.

View our latest analysis for Medical Ikkou GroupLtd

How Much Debt Does Medical Ikkou GroupLtd Carry?

The image below, which you can click on for greater detail, shows that at November 2020 Medical Ikkou GroupLtd had debt of JP¥11.1b, up from JP¥10.1b in one year. However, it also had JP¥5.46b in cash, and so its net debt is JP¥5.63b.

How Strong Is Medical Ikkou GroupLtd's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Medical Ikkou GroupLtd had liabilities of JP¥8.00b due within 12 months and liabilities of JP¥8.96b due beyond that. On the other hand, it had cash of JP¥5.46b and JP¥4.94b worth of receivables due within a year. So it has liabilities totalling JP¥6.57b more than its cash and near-term receivables, combined.

While this might seem like a lot, it is not so bad since Medical Ikkou GroupLtd has a market capitalization of JP¥11.9b, and so it could probably strengthen its balance sheet by raising capital if it needed to. But we definitely want to keep our eyes open to indications that its debt is bringing too much risk.

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.

Medical Ikkou GroupLtd has a debt to EBITDA ratio of 3.1, which signals significant debt, but is still pretty reasonable for most types of business. But its EBIT was about 39.7 times its interest expense, implying the company isn't really paying a high cost to maintain that level of debt. Even were the low cost to prove unsustainable, that is a good sign. Unfortunately, Medical Ikkou GroupLtd's EBIT flopped 15% over the last four quarters. If earnings continue to decline at that rate then handling the debt will be more difficult than taking three children under 5 to a fancy pants restaurant. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since Medical Ikkou GroupLtd 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, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So it's worth checking how much of that EBIT is backed by free cash flow. In the last three years, Medical Ikkou GroupLtd's free cash flow amounted to 37% of its EBIT, less than we'd expect. That's not great, when it comes to paying down debt.

Our View

Medical Ikkou GroupLtd's EBIT growth rate and net debt to EBITDA definitely weigh on it, in our esteem. But its interest cover tells a very different story, and suggests some resilience. Taking the abovementioned factors together we do think Medical Ikkou GroupLtd's debt poses some risks to the business. While that debt can boost returns, we think the company has enough leverage now. 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. We've identified 3 warning signs with Medical Ikkou GroupLtd (at least 2 which are potentially serious) , and understanding them should be part of your investment process.

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.

If you decide to trade Medical Ikkou GroupLtd, use the lowest-cost* platform that is rated #1 Overall by Barron’s, Interactive Brokers. Trade stocks, options, futures, forex, bonds and funds on 135 markets, all from a single integrated account. Promoted

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.
^*Interactive Brokers Rated Lowest Cost Broker by StockBrokers.com Annual Online Review 2020

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.