We Think Oji Holdings (TSE:3861) Is Taking Some Risk With Its Debt

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 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 Oji Holdings Corporation (TSE:3861) makes use of debt. But is this debt a concern to shareholders?

When Is Debt A Problem?

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. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. The first step when considering a company's debt levels is to consider its cash and debt together.

Check out our latest analysis for Oji Holdings

What Is Oji Holdings's Net Debt?

As you can see below, Oji Holdings had JP¥778.1b of debt, at December 2023, which is about the same as the year before. You can click the chart for greater detail. However, it does have JP¥86.7b in cash offsetting this, leading to net debt of about JP¥691.4b.

A Look At Oji Holdings' Liabilities

Zooming in on the latest balance sheet data, we can see that Oji Holdings had liabilities of JP¥658.3b due within 12 months and liabilities of JP¥711.0b due beyond that. On the other hand, it had cash of JP¥86.7b and JP¥386.7b worth of receivables due within a year. So it has liabilities totalling JP¥896.0b more than its cash and near-term receivables, combined.

Given this deficit is actually higher than the company's market capitalization of JP¥607.9b, we think shareholders really should watch Oji Holdings's debt levels, like a parent watching their child ride a bike for the first time. 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.

Oji Holdings has a debt to EBITDA ratio of 4.3, which signals significant debt, but is still pretty reasonable for most types of business. However, its interest coverage of 133 is very high, suggesting that the interest expense on the debt is currently quite low. Unfortunately, Oji Holdings saw its EBIT slide 3.2% in the last twelve months. If earnings continue on that decline then managing that debt will be difficult like delivering hot soup on a unicycle. 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 Oji 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 business needs free cash flow to pay off debt; accounting profits just don't cut it. So the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. In the last three years, Oji Holdings created free cash flow amounting to 15% of its EBIT, an uninspiring performance. For us, cash conversion that low sparks a little paranoia about is ability to extinguish debt.

Our View

We'd go so far as to say Oji Holdings's level of total liabilities was disappointing. But on the bright side, its interest cover is a good sign, and makes us more optimistic. Overall, it seems to us that Oji Holdings's balance sheet is really quite a risk to the business. So we're almost as wary of this stock as a hungry kitten is about falling into its owner's fish pond: once bitten, twice shy, as they say. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. Be aware that Oji Holdings is showing 1 warning sign in our investment analysis , you should know about...

When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.

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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.