Does Alfresa Holdings (TSE:2784) Have A Healthy 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.' 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 can see that Alfresa Holdings Corporation (TSE:2784) does use debt in its business. But the more important question is: how much risk is that debt creating?

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. 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.

See our latest analysis for Alfresa Holdings

How Much Debt Does Alfresa Holdings Carry?

The image below, which you can click on for greater detail, shows that at September 2024 Alfresa Holdings had debt of JP¥30.0b, up from JP¥12.0b in one year. However, it does have JP¥206.9b in cash offsetting this, leading to net cash of JP¥176.9b.

How Strong Is Alfresa Holdings' Balance Sheet?

According to the last reported balance sheet, Alfresa Holdings had liabilities of JP¥913.6b due within 12 months, and liabilities of JP¥62.2b due beyond 12 months. On the other hand, it had cash of JP¥206.9b and JP¥651.8b worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by JP¥117.1b.

While this might seem like a lot, it is not so bad since Alfresa Holdings has a market capitalization of JP¥392.6b, and so it could probably strengthen its balance sheet by raising capital if it needed to. But we definitely want to keep our eyes open to indications that its debt is bringing too much risk. While it does have liabilities worth noting, Alfresa Holdings also has more cash than debt, so we're pretty confident it can manage its debt safely.

The good news is that Alfresa Holdings has increased its EBIT by 4.3% over twelve months, which should ease any concerns about debt repayment. There's no doubt that we learn most about debt from the balance sheet. But it is future earnings, more than anything, that will determine Alfresa Holdings's ability to maintain a healthy balance sheet going forward. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. While Alfresa Holdings 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. During the last three years, Alfresa Holdings produced sturdy free cash flow equating to 56% of its EBIT, about what we'd expect. This cold hard cash means it can reduce its debt when it wants to.

Summing Up

While Alfresa Holdings does have more liabilities than liquid assets, it also has net cash of JP¥176.9b. So we are not troubled with Alfresa Holdings'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. These risks can be hard to spot. Every company has them, and we've spotted 2 warning signs for Alfresa Holdings you should know about.

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. 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.