Does Ohki Healthcare HoldingsLtd (TYO:3417) Have A Healthy Balance Sheet?

Warren Buffett famously said, 'Volatility is far from synonymous with risk.' So it seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. As with many other companies Ohki Healthcare Holdings Co.,Ltd. (TYO:3417) makes use of debt. But the more important question is: how much risk is that debt creating?

Why Does Debt Bring Risk?

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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. The first step when considering a company's debt levels is to consider its cash and debt together.

Check out our latest analysis for Ohki Healthcare HoldingsLtd

How Much Debt Does Ohki Healthcare HoldingsLtd Carry?

The image below, which you can click on for greater detail, shows that at September 2020 Ohki Healthcare HoldingsLtd had debt of JP¥8.17b, up from JP¥7.17b in one year. However, it also had JP¥4.01b in cash, and so its net debt is JP¥4.16b.

How Strong Is Ohki Healthcare HoldingsLtd's Balance Sheet?

The latest balance sheet data shows that Ohki Healthcare HoldingsLtd had liabilities of JP¥86.8b due within a year, and liabilities of JP¥2.54b falling due after that. Offsetting these obligations, it had cash of JP¥4.01b as well as receivables valued at JP¥62.9b due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by JP¥22.4b.

When you consider that this deficiency exceeds the company's JP¥18.9b market capitalization, you might well be inclined to review the balance sheet intently. Hypothetically, extremely heavy dilution would be required if the company were forced to pay down its liabilities by raising capital at the current share price.

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). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

Ohki Healthcare HoldingsLtd has a low debt to EBITDA ratio of only 1.1. And remarkably, despite having net debt, it actually received more in interest over the last twelve months than it had to pay. So it's fair to say it can handle debt like a hotshot teppanyaki chef handles cooking. In addition to that, we're happy to report that Ohki Healthcare HoldingsLtd has boosted its EBIT by 70%, thus reducing the spectre of future debt repayments. There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since Ohki Healthcare HoldingsLtd will need earnings to service that debt. So if you're keen to discover more about its earnings, it might be worth checking out this graph of its long term earnings trend.

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. Considering the last three years, Ohki Healthcare HoldingsLtd actually recorded a cash outflow, overall. Debt is far more risky for companies with unreliable free cash flow, so shareholders should be hoping that the past expenditure will produce free cash flow in the future.

Our View

While Ohki Healthcare HoldingsLtd's conversion of EBIT to free cash flow has us nervous. To wit both its interest cover and EBIT growth rate were encouraging signs. We should also note that Healthcare industry companies like Ohki Healthcare HoldingsLtd commonly do use debt without problems. We think that Ohki Healthcare HoldingsLtd's debt does make it a bit risky, after considering the aforementioned data points together. Not all risk is bad, as it can boost share price returns if it pays off, but this debt risk is worth keeping in mind. 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. To that end, you should be aware of the 1 warning sign we've spotted with Ohki Healthcare HoldingsLtd .

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. 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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