Is Orchestra Holdings (TSE:6533) 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 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. Importantly, Orchestra Holdings Inc. (TSE:6533) does carry debt. But the more important question is: how much risk is that debt creating?

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. If things get really bad, the lenders can take control of the business. 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 step when considering a company's debt levels is to consider its cash and debt together.

See our latest analysis for Orchestra Holdings

What Is Orchestra Holdings's Net Debt?

As you can see below, at the end of March 2024, Orchestra Holdings had JP¥3.16b of debt, up from JP¥2.19b a year ago. Click the image for more detail. But it also has JP¥4.17b in cash to offset that, meaning it has JP¥1.01b net cash.

How Strong Is Orchestra Holdings' Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Orchestra Holdings had liabilities of JP¥5.04b due within 12 months and liabilities of JP¥2.15b due beyond that. Offsetting this, it had JP¥4.17b in cash and JP¥3.51b in receivables that were due within 12 months. So it actually has JP¥492.0m more liquid assets than total liabilities.

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

But the bad news is that Orchestra Holdings has seen its EBIT plunge 18% in the last twelve months. We think hat kind of performance, if repeated frequently, could well lead to difficulties for the stock. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since Orchestra Holdings will need earnings to service that debt. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. Orchestra 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. Over the most recent three years, Orchestra Holdings recorded free cash flow worth 53% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This free cash flow puts the company in a good position to pay down debt, when appropriate.

Summing Up

While it is always sensible to investigate a company's debt, in this case Orchestra Holdings has JP¥1.01b in net cash and a decent-looking balance sheet. So we are not troubled with Orchestra Holdings's debt use. 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. To that end, you should learn about the 4 warning signs we've spotted with Orchestra Holdings (including 1 which is concerning) .

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.

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.

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