Hakuhodo DY Holdings (TSE:2433) Takes On Some Risk With Its Use Of Debt

Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. We can see that Hakuhodo DY Holdings Inc (TSE:2433) does use debt in its business. But is this debt a concern to shareholders?

What Risk Does Debt Bring?

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. 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. 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 Hakuhodo DY Holdings

What Is Hakuhodo DY Holdings's Debt?

As you can see below, at the end of December 2023, Hakuhodo DY Holdings had JP¥188.1b of debt, up from JP¥123.6b a year ago. Click the image for more detail. However, its balance sheet shows it holds JP¥188.4b in cash, so it actually has JP¥316.0m net cash.

A Look At Hakuhodo DY Holdings' Liabilities

According to the last reported balance sheet, Hakuhodo DY Holdings had liabilities of JP¥577.6b due within 12 months, and liabilities of JP¥72.1b due beyond 12 months. Offsetting this, it had JP¥188.4b in cash and JP¥371.6b in receivables that were due within 12 months. So it has liabilities totalling JP¥89.7b more than its cash and near-term receivables, combined.

Given Hakuhodo DY Holdings has a market capitalization of JP¥546.8b, it's hard to believe these liabilities pose much threat. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time. Despite its noteworthy liabilities, Hakuhodo DY Holdings boasts net cash, so it's fair to say it does not have a heavy debt load!

It is just as well that Hakuhodo DY Holdings's load is not too heavy, because its EBIT was down 42% over the last year. When it comes to paying off debt, falling earnings are no more useful than sugary sodas are for your health. The balance sheet is clearly the area to focus on when you are analysing debt. But it is future earnings, more than anything, that will determine Hakuhodo DY Holdings's ability to maintain a healthy balance sheet going forward. 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. Hakuhodo DY Holdings 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, Hakuhodo DY Holdings created free cash flow amounting to 16% of its EBIT, an uninspiring performance. For us, cash conversion that low sparks a little paranoia about is ability to extinguish debt.

Summing Up

Although Hakuhodo DY Holdings's balance sheet isn't particularly strong, due to the total liabilities, it is clearly positive to see that it has net cash of JP¥316.0m. So although we see some areas for improvement, we're not too worried about Hakuhodo DY Holdings's balance sheet. 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. For example Hakuhodo DY Holdings has 3 warning signs (and 1 which is significant) we think you should know about.

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

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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.