Is Sapporo Holdings (TSE:2501) Using Too Much Debt?

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.' So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. We note that Sapporo Holdings Limited (TSE:2501) does have debt on its balance sheet. But is this debt a concern to shareholders?

When Is Debt Dangerous?

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. If things get really bad, the lenders can take control of the business. 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, debt can be an important tool in businesses, particularly capital heavy businesses. When we think about a company's use of debt, we first look at cash and debt together.

Check out our latest analysis for Sapporo Holdings

How Much Debt Does Sapporo Holdings Carry?

As you can see below, Sapporo Holdings had JP¥235.7b of debt, at March 2024, which is about the same as the year before. You can click the chart for greater detail. However, because it has a cash reserve of JP¥21.7b, its net debt is less, at about JP¥214.0b.

How Strong Is Sapporo Holdings' Balance Sheet?

The latest balance sheet data shows that Sapporo Holdings had liabilities of JP¥187.3b due within a year, and liabilities of JP¥292.1b falling due after that. Offsetting this, it had JP¥21.7b in cash and JP¥77.5b in receivables that were due within 12 months. So its liabilities total JP¥380.2b more than the combination of its cash and short-term receivables.

This is a mountain of leverage relative to its market capitalization of JP¥438.0b. Should its lenders demand that it shore up the balance sheet, shareholders would likely face severe dilution.

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). The advantage of this approach is that we take into account both the absolute quantum of debt (with net debt to EBITDA) and the actual interest expenses associated with that debt (with its interest cover ratio).

Strangely Sapporo Holdings has a sky high EBITDA ratio of 5.6, implying high debt, but a strong interest coverage of 20.1. This means that unless the company has access to very cheap debt, that interest expense will likely grow in the future. It is well worth noting that Sapporo Holdings's EBIT shot up like bamboo after rain, gaining 64% in the last twelve months. That'll make it easier to manage its debt. There's no doubt that we learn most about debt from the balance sheet. But ultimately the future profitability of the business will decide if Sapporo Holdings can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. Happily for any shareholders, Sapporo Holdings actually produced more free cash flow than EBIT over the last three years. There's nothing better than incoming cash when it comes to staying in your lenders' good graces.

Our View

The good news is that Sapporo Holdings's demonstrated ability to cover its interest expense with its EBIT delights us like a fluffy puppy does a toddler. But the stark truth is that we are concerned by its net debt to EBITDA. All these things considered, it appears that Sapporo Holdings can comfortably handle its current debt levels. Of course, while this leverage can enhance returns on equity, it does bring more risk, so it's worth keeping an eye on this one. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. We've identified 1 warning sign with Sapporo Holdings , and understanding them should be part of your investment process.

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

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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.

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