Is Gokurakuyu Holdings (TYO:2340) Using Too Much Debt?

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.' 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 can see that Gokurakuyu Holdings Co., Ltd. (TYO:2340) does use debt in its business. But is this debt a concern to shareholders?

What Risk Does Debt Bring?

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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. 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.

Check out our latest analysis for Gokurakuyu Holdings

What Is Gokurakuyu Holdings's Net Debt?

The image below, which you can click on for greater detail, shows that at September 2020 Gokurakuyu Holdings had debt of JP¥12.4b, up from JP¥11.1b in one year. However, because it has a cash reserve of JP¥4.56b, its net debt is less, at about JP¥7.79b.

How Strong Is Gokurakuyu Holdings' Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Gokurakuyu Holdings had liabilities of JP¥7.20b due within 12 months and liabilities of JP¥9.58b due beyond that. Offsetting this, it had JP¥4.56b in cash and JP¥172.0m in receivables that were due within 12 months. So it has liabilities totalling JP¥12.0b more than its cash and near-term receivables, combined.

This deficit casts a shadow over the JP¥5.37b company, like a colossus towering over mere mortals. So we definitely think shareholders need to watch this one closely. At the end of the day, Gokurakuyu Holdings would probably need a major re-capitalization if its creditors were to demand repayment. The balance sheet is clearly the area to focus on when you are analysing debt. But you can't view debt in total isolation; since Gokurakuyu Holdings will need earnings to service that debt. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

In the last year Gokurakuyu Holdings had a loss before interest and tax, and actually shrunk its revenue by 23%, to JP¥12b. To be frank that doesn't bode well.

Caveat Emptor

Not only did Gokurakuyu Holdings's revenue slip over the last twelve months, but it also produced negative earnings before interest and tax (EBIT). Its EBIT loss was a whopping JP¥1.3b. Considering that alongside the liabilities mentioned above make us nervous about the company. It would need to improve its operations quickly for us to be interested in it. Not least because it had negative free cash flow of JP¥1.0m over the last twelve months. That means it's on the risky side of things. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. To that end, you should learn about the 3 warning signs we've spotted with Gokurakuyu Holdings (including 1 which is a bit unpleasant) .

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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