Toho (TSE:9602) Could Easily Take On More 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. We can see that Toho Co., Ltd. (TSE:9602) does use debt in its business. But the more important question is: how much risk is that debt creating?

When Is Debt A Problem?

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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. 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. When we think about a company's use of debt, we first look at cash and debt together.

Check out our latest analysis for Toho

What Is Toho's Debt?

The image below, which you can click on for greater detail, shows that at August 2024 Toho had debt of JP¥22.6b, up from JP¥826.0m in one year. However, its balance sheet shows it holds JP¥90.6b in cash, so it actually has JP¥68.0b net cash.

How Strong Is Toho's Balance Sheet?

The latest balance sheet data shows that Toho had liabilities of JP¥92.0b due within a year, and liabilities of JP¥60.6b falling due after that. Offsetting this, it had JP¥90.6b in cash and JP¥60.1b in receivables that were due within 12 months. So these liquid assets roughly match the total liabilities.

Having regard to Toho's size, it seems that its liquid assets are well balanced with its total liabilities. So it's very unlikely that the JP¥1.01t company is short on cash, but still worth keeping an eye on the balance sheet. While it does have liabilities worth noting, Toho also has more cash than debt, so we're pretty confident it can manage its debt safely.

On top of that, Toho grew its EBIT by 40% over the last twelve months, and that growth will make it easier to handle its debt. 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 Toho 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, while the tax-man may adore accounting profits, lenders only accept cold hard cash. While Toho 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, Toho recorded free cash flow of 46% of its EBIT, which is weaker than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.

Summing Up

We could understand if investors are concerned about Toho's liabilities, but we can be reassured by the fact it has has net cash of JP¥68.0b. And we liked the look of last year's 40% year-on-year EBIT growth. So we don't think Toho's use of debt is risky. Over time, share prices tend to follow earnings per share, so if you're interested in Toho, you may well want to click here to check an interactive graph of its earnings per share history.

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.