Hodogaya Chemical (TSE:4112) Could Easily Take On More Debt

The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' 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. Importantly, Hodogaya Chemical Co., Ltd. (TSE:4112) does carry debt. But the real question is whether this debt is making the company risky.

What Risk Does Debt Bring?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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.

View our latest analysis for Hodogaya Chemical

How Much Debt Does Hodogaya Chemical Carry?

As you can see below, Hodogaya Chemical had JP¥9.19b of debt at June 2024, down from JP¥10.3b a year prior. But it also has JP¥13.7b in cash to offset that, meaning it has JP¥4.47b net cash.

A Look At Hodogaya Chemical's Liabilities

We can see from the most recent balance sheet that Hodogaya Chemical had liabilities of JP¥14.8b falling due within a year, and liabilities of JP¥8.66b due beyond that. Offsetting these obligations, it had cash of JP¥13.7b as well as receivables valued at JP¥11.9b due within 12 months. So it can boast JP¥2.05b more liquid assets than total liabilities.

This surplus suggests that Hodogaya Chemical has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Simply put, the fact that Hodogaya Chemical has more cash than debt is arguably a good indication that it can manage its debt safely.

Better yet, Hodogaya Chemical grew its EBIT by 113% last year, which is an impressive improvement. If maintained that growth will make the debt even more manageable in the years ahead. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately the future profitability of the business will decide if Hodogaya Chemical can strengthen its balance sheet over time. 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. Hodogaya Chemical may have net cash on the balance sheet, but it is still interesting to look at how well the business converts its earnings before interest and tax (EBIT) to free cash flow, because that will influence both its need for, and its capacity to manage debt. In the last three years, Hodogaya Chemical's free cash flow amounted to 33% of its EBIT, less than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.

Summing Up

While it is always sensible to investigate a company's debt, in this case Hodogaya Chemical has JP¥4.47b in net cash and a decent-looking balance sheet. And it impressed us with its EBIT growth of 113% over the last year. So is Hodogaya Chemical's debt a risk? It doesn't seem so to us. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. We've identified 1 warning sign with Hodogaya Chemical , and understanding them should be part of your investment process.

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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

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.