Is Tokyo Ohka Kogyo (TSE:4186) Using Too Much Debt?

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 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. Importantly, Tokyo Ohka Kogyo Co., Ltd. (TSE:4186) does carry debt. But is this debt a concern to shareholders?

Why Does Debt Bring Risk?

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

View our latest analysis for Tokyo Ohka Kogyo

How Much Debt Does Tokyo Ohka Kogyo Carry?

The chart below, which you can click on for greater detail, shows that Tokyo Ohka Kogyo had JP¥10.6b in debt in June 2024; about the same as the year before. But on the other hand it also has JP¥66.1b in cash, leading to a JP¥55.5b net cash position.

How Healthy Is Tokyo Ohka Kogyo's Balance Sheet?

According to the last reported balance sheet, Tokyo Ohka Kogyo had liabilities of JP¥53.5b due within 12 months, and liabilities of JP¥14.2b due beyond 12 months. Offsetting this, it had JP¥66.1b in cash and JP¥41.3b in receivables that were due within 12 months. So it can boast JP¥39.8b more liquid assets than total liabilities.

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

But the other side of the story is that Tokyo Ohka Kogyo saw its EBIT decline by 3.9% over the last year. If earnings continue to decline at that rate the company may have increasing difficulty managing its debt load. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Tokyo Ohka Kogyo 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 company can only pay off debt with cold hard cash, not accounting profits. While Tokyo Ohka Kogyo 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. Looking at the most recent three years, Tokyo Ohka Kogyo recorded free cash flow of 28% of its EBIT, which is weaker than we'd expect. That's not great, when it comes to paying down debt.

Summing Up

While we empathize with investors who find debt concerning, you should keep in mind that Tokyo Ohka Kogyo has net cash of JP¥55.5b, as well as more liquid assets than liabilities. So we don't have any problem with Tokyo Ohka Kogyo's use of debt. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. Be aware that Tokyo Ohka Kogyo 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.