These 4 Measures Indicate That Hodogaya Chemical (TSE:4112) Is Using Debt Reasonably Well

Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' 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 Hodogaya Chemical Co., Ltd. (TSE:4112) makes use of debt. But is this debt a concern to shareholders?

What Risk Does Debt Bring?

Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. 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 Hodogaya Chemical

What Is Hodogaya Chemical's Net Debt?

As you can see below, Hodogaya Chemical had JP¥8.99b of debt at September 2024, down from JP¥10.0b a year prior. But on the other hand it also has JP¥13.7b in cash, leading to a JP¥4.72b net cash position.

How Healthy Is Hodogaya Chemical's Balance Sheet?

We can see from the most recent balance sheet that Hodogaya Chemical had liabilities of JP¥14.6b falling due within a year, and liabilities of JP¥8.11b due beyond that. Offsetting this, it had JP¥13.7b in cash and JP¥10.5b in receivables that were due within 12 months. So it can boast JP¥1.43b 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.

Even more impressive was the fact that Hodogaya Chemical grew its EBIT by 137% over twelve months. That boost will make it even easier to pay down debt going forward. 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 Hodogaya Chemical'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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. While Hodogaya Chemical 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. In the last three years, Hodogaya Chemical's free cash flow amounted to 26% of its EBIT, less than we'd expect. That's not great, when it comes to paying down debt.

Summing Up

While it is always sensible to investigate a company's debt, in this case Hodogaya Chemical has JP¥4.72b in net cash and a decent-looking balance sheet. And it impressed us with its EBIT growth of 137% over the last year. So we don't think Hodogaya Chemical's use of debt is risky. Over time, share prices tend to follow earnings per share, so if you're interested in Hodogaya Chemical, you may well want to click here to check an interactive graph of its earnings per share history.

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.