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.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. As with many other companies Kusuri No Aoki Holdings Co., Ltd. (TSE:3549) makes use of debt. But is this debt a concern to shareholders?
Why Does Debt Bring Risk?
Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. 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. The first step when considering a company's debt levels is to consider its cash and debt together.
See our latest analysis for Kusuri No Aoki Holdings
What Is Kusuri No Aoki Holdings's Net Debt?
The image below, which you can click on for greater detail, shows that at May 2024 Kusuri No Aoki Holdings had debt of JPĀ„90.0b, up from JPĀ„80.2b in one year. However, because it has a cash reserve of JPĀ„49.1b, its net debt is less, at about JPĀ„40.9b.
A Look At Kusuri No Aoki Holdings' Liabilities
Zooming in on the latest balance sheet data, we can see that Kusuri No Aoki Holdings had liabilities of JPĀ„98.1b due within 12 months and liabilities of JPĀ„88.0b due beyond that. Offsetting these obligations, it had cash of JPĀ„49.1b as well as receivables valued at JPĀ„28.5b due within 12 months. So its liabilities total JPĀ„108.4b more than the combination of its cash and short-term receivables.
While this might seem like a lot, it is not so bad since Kusuri No Aoki Holdings has a market capitalization of JPĀ„343.7b, and so it could probably strengthen its balance sheet by raising capital if it needed to. But it's clear that we should definitely closely examine whether it can manage its debt without dilution.
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). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.
Kusuri No Aoki Holdings's net debt is only 1.3 times its EBITDA. And its EBIT easily covers its interest expense, being 78.7 times the size. So you could argue it is no more threatened by its debt than an elephant is by a mouse. Another good sign is that Kusuri No Aoki Holdings has been able to increase its EBIT by 21% in twelve months, making it easier to pay down debt. There's no doubt that we learn most about debt from the balance sheet. But it is future earnings, more than anything, that will determine Kusuri No Aoki 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. So it's worth checking how much of that EBIT is backed by free cash flow. In the last three years, Kusuri No Aoki Holdings created free cash flow amounting to 20% of its EBIT, an uninspiring performance. For us, cash conversion that low sparks a little paranoia about is ability to extinguish debt.
Our View
On our analysis Kusuri No Aoki Holdings's interest cover should signal that it won't have too much trouble with its debt. However, our other observations weren't so heartening. For instance it seems like it has to struggle a bit to convert EBIT to free cash flow. Considering this range of data points, we think Kusuri No Aoki Holdings is in a good position to manage its debt levels. Having said that, the load is sufficiently heavy that we would recommend any shareholders keep a close eye on it. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. We've identified 1 warning sign with Kusuri No Aoki Holdings , and understanding them should be part of your investment process.
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.
About TSE:3549
Kusuri No Aoki Holdings
Engages in the retail of pharmaceuticals, cosmetics, and daily goods in Japan.
Excellent balance sheet with moderate growth potential.
