Is OhmoriyaLtd (TYO:2917) A Risky Investment?

Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that '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. Importantly, Ohmoriya Co.,Ltd. (TYO:2917) does carry debt. But should shareholders be worried about its use of debt?

What Risk Does Debt Bring?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. Of course, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. When we think about a company's use of debt, we first look at cash and debt together.

Check out our latest analysis for OhmoriyaLtd

How Much Debt Does OhmoriyaLtd Carry?

You can click the graphic below for the historical numbers, but it shows that OhmoriyaLtd had JP¥229.0m of debt in September 2020, down from JP¥301.0m, one year before. But on the other hand it also has JP¥779.0m in cash, leading to a JP¥550.0m net cash position.

How Strong Is OhmoriyaLtd's Balance Sheet?

We can see from the most recent balance sheet that OhmoriyaLtd had liabilities of JP¥2.06b falling due within a year, and liabilities of JP¥561.0m due beyond that. Offsetting these obligations, it had cash of JP¥779.0m as well as receivables valued at JP¥2.82b due within 12 months. So it can boast JP¥973.0m more liquid assets than total liabilities.

This excess liquidity suggests that OhmoriyaLtd is taking a careful approach to debt. Because it has plenty of assets, it is unlikely to have trouble with its lenders. Simply put, the fact that OhmoriyaLtd has more cash than debt is arguably a good indication that it can manage its debt safely.

On the other hand, OhmoriyaLtd saw its EBIT drop by 5.2% in the last twelve months. That sort of decline, if sustained, will obviously make debt harder to handle. 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 OhmoriyaLtd 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.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. While OhmoriyaLtd 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, OhmoriyaLtd saw substantial negative free cash flow, in total. While investors are no doubt expecting a reversal of that situation in due course, it clearly does mean its use of debt is more risky.

Summing up

While it is always sensible to investigate a company's debt, in this case OhmoriyaLtd has JP¥550.0m in net cash and a decent-looking balance sheet. So we are not troubled with OhmoriyaLtd's debt use. 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. Be aware that OhmoriyaLtd is showing 1 warning sign in our investment analysis , you should know about...

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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