Ohki Healthcare HoldingsLtd (TYO:3417) Has A Somewhat Strained Balance Sheet

Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. We can see that Ohki Healthcare Holdings Co.,Ltd. (TYO:3417) does use debt in its business. But is this debt a concern to shareholders?

What Risk Does Debt Bring?

Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. If things get really bad, the lenders can take control of the business. 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, plenty of companies use debt to fund growth, without any negative consequences. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

See our latest analysis for Ohki Healthcare HoldingsLtd

How Much Debt Does Ohki Healthcare HoldingsLtd Carry?

You can click the graphic below for the historical numbers, but it shows that as of December 2020 Ohki Healthcare HoldingsLtd had JP¥7.97b of debt, an increase on JP¥5.87b, over one year. On the flip side, it has JP¥3.83b in cash leading to net debt of about JP¥4.14b.

How Strong Is Ohki Healthcare HoldingsLtd's Balance Sheet?

We can see from the most recent balance sheet that Ohki Healthcare HoldingsLtd had liabilities of JP¥88.9b falling due within a year, and liabilities of JP¥2.64b due beyond that. Offsetting these obligations, it had cash of JP¥3.83b as well as receivables valued at JP¥63.9b due within 12 months. So it has liabilities totalling JP¥23.8b more than its cash and near-term receivables, combined.

Given this deficit is actually higher than the company's market capitalization of JP¥17.2b, we think shareholders really should watch Ohki Healthcare HoldingsLtd's debt levels, like a parent watching their child ride a bike for the first time. In the scenario where the company had to clean up its balance sheet quickly, it seems likely shareholders would suffer extensive 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). 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 0.96. But the really cool thing is that it actually managed to receive more interest than it paid, over the last year. So it's fair to say it can handle debt like a hotshot teppanyaki chef handles cooking. Even more impressive was the fact that Ohki Healthcare HoldingsLtd grew its EBIT by 103% over twelve months. That boost will make it even easier to pay down debt going forward. The balance sheet is clearly the area to focus on when you are analysing debt. But it is Ohki Healthcare HoldingsLtd's earnings that will influence how the balance sheet holds up in the future. 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 company can only pay off debt with cold hard cash, not accounting profits. So the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. Over the last three years, Ohki Healthcare HoldingsLtd recorded negative free cash flow, in total. 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. For example, its interest cover and EBIT growth rate give us some confidence in its ability to manage its debt. It's also worth noting that Ohki Healthcare HoldingsLtd is in the Healthcare industry, which is often considered to be quite defensive. Taking the abovementioned factors together we do think Ohki Healthcare HoldingsLtd's debt poses some risks to the business. While that debt can boost returns, we think the company has enough leverage now. Above most other metrics, we think its important to track how fast earnings per share is growing, if at all. If you've also come to that realization, you're in luck, because today you can view this interactive graph of Ohki Healthcare HoldingsLtd's earnings per share history for free.

At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.

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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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