Is Welcia Holdings (TSE:3141) A Risky Investment?

The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says 'The biggest investment risk is not the volatility of prices, but whether you will suffer a 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. As with many other companies Welcia Holdings Co., Ltd. (TSE:3141) makes use of debt. But is this debt a concern to shareholders?

Why Does Debt Bring Risk?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. 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.

See our latest analysis for Welcia Holdings

What Is Welcia Holdings's Debt?

You can click the graphic below for the historical numbers, but it shows that Welcia Holdings had JP¥36.3b of debt in August 2024, down from JP¥45.5b, one year before. However, it does have JP¥82.8b in cash offsetting this, leading to net cash of JP¥46.5b.

How Strong Is Welcia Holdings' Balance Sheet?

The latest balance sheet data shows that Welcia Holdings had liabilities of JP¥285.1b due within a year, and liabilities of JP¥82.0b falling due after that. Offsetting these obligations, it had cash of JP¥82.8b as well as receivables valued at JP¥80.4b due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by JP¥204.0b.

While this might seem like a lot, it is not so bad since Welcia Holdings has a market capitalization of JP¥400.0b, 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. While it does have liabilities worth noting, Welcia Holdings also has more cash than debt, so we're pretty confident it can manage its debt safely.

But the bad news is that Welcia Holdings has seen its EBIT plunge 19% in the last twelve months. We think hat kind of performance, if repeated frequently, could well lead to difficulties for the stock. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Welcia Holdings's ability to maintain a healthy balance sheet going forward. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. While Welcia Holdings 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, Welcia Holdings 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

Although Welcia Holdings's balance sheet isn't particularly strong, due to the total liabilities, it is clearly positive to see that it has net cash of JP¥46.5b. The cherry on top was that in converted 110% of that EBIT to free cash flow, bringing in JP¥75b. So we are not troubled with Welcia Holdings's debt use. Over time, share prices tend to follow earnings per share, so if you're interested in Welcia Holdings, you may well want to click here to check an interactive graph of its earnings per share history.

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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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.