We Think Kusuri No Aoki Holdings (TSE:3549) Can Stay On Top Of Its Debt

Warren Buffett famously said, 'Volatility is far from synonymous with risk.' 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. We note that Kusuri No Aoki Holdings Co., Ltd. (TSE:3549) does have debt on its balance sheet. But the real question is whether this debt is making the company risky.

When Is Debt A Problem?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. If things get really bad, the lenders can take control of the business. 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. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. When we examine debt levels, we first consider both cash and debt levels, together.

Check out our latest analysis for Kusuri No Aoki Holdings

What Is Kusuri No Aoki Holdings's Debt?

As you can see below, Kusuri No Aoki Holdings had JP¥76.7b of debt, at February 2024, which is about the same as the year before. You can click the chart for greater detail. However, it also had JP¥40.1b in cash, and so its net debt is JP¥36.6b.

How Strong Is Kusuri No Aoki Holdings' Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Kusuri No Aoki Holdings had liabilities of JP¥85.6b due within 12 months and liabilities of JP¥81.1b due beyond that. Offsetting this, it had JP¥40.1b in cash and JP¥25.4b in receivables that were due within 12 months. So its liabilities total JP¥101.3b 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 JP¥272.6b, 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.

In order to size up a company's debt relative to its earnings, we calculate its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and its earnings before interest and tax (EBIT) divided by its interest expense (its interest cover). 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 1.2 times its EBITDA. And its EBIT covers its interest expense a whopping 65.5 times over. So we're pretty relaxed about its super-conservative use of debt. Kusuri No Aoki Holdings's EBIT was pretty flat over the last year, but that shouldn't be an issue given the it doesn't have a lot of debt. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately the future profitability of the business will decide if Kusuri No Aoki Holdings can strengthen its balance sheet over time. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So we always check how much of that EBIT is translated into free cash flow. In the last three years, Kusuri No Aoki Holdings created free cash flow amounting to 9.8% of its EBIT, an uninspiring performance. That limp level of cash conversion undermines its ability to manage and pay down debt.

Our View

When it comes to the balance sheet, the standout positive for Kusuri No Aoki Holdings was the fact that it seems able to cover its interest expense with its EBIT confidently. But the other factors we noted above weren't so encouraging. For example, its conversion of EBIT to free cash flow makes us a little nervous about its debt. Looking at all this data makes us feel a little cautious about Kusuri No Aoki Holdings's debt levels. While debt does have its upside in higher potential returns, we think shareholders should definitely consider how debt levels might make the stock more risky. 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. Case in point: We've spotted 1 warning sign for Kusuri No Aoki Holdings you should be aware of.

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.