Is Otsuka Holdings (TSE:4578) A Risky Investment?

David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the permanent loss of capital.' 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. As with many other companies Otsuka Holdings Co., Ltd. (TSE:4578) makes use of debt. But the real question is whether this debt is making the company risky.

What Risk Does Debt Bring?

Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. 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, plenty of companies use debt to fund growth, without any negative consequences. When we think about a company's use of debt, we first look at cash and debt together.

Check out our latest analysis for Otsuka Holdings

How Much Debt Does Otsuka Holdings Carry?

You can click the graphic below for the historical numbers, but it shows that as of December 2023 Otsuka Holdings had JP¥138.6b of debt, an increase on JP¥120.2b, over one year. However, its balance sheet shows it holds JP¥513.3b in cash, so it actually has JP¥374.7b net cash.

How Strong Is Otsuka Holdings' Balance Sheet?

According to the last reported balance sheet, Otsuka Holdings had liabilities of JP¥667.2b due within 12 months, and liabilities of JP¥257.7b due beyond 12 months. Offsetting this, it had JP¥513.3b in cash and JP¥493.7b in receivables that were due within 12 months. So it actually has JP¥82.1b more liquid assets than total liabilities.

This short term liquidity is a sign that Otsuka Holdings could probably pay off its debt with ease, as its balance sheet is far from stretched. Succinctly put, Otsuka Holdings boasts net cash, so it's fair to say it does not have a heavy debt load!

In addition to that, we're happy to report that Otsuka Holdings has boosted its EBIT by 57%, thus reducing the spectre of future debt repayments. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Otsuka Holdings'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 Otsuka Holdings 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. Over the most recent three years, Otsuka Holdings recorded free cash flow worth 53% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This cold hard cash means it can reduce its debt when it wants to.

Summing Up

While we empathize with investors who find debt concerning, you should keep in mind that Otsuka Holdings has net cash of JP¥374.7b, as well as more liquid assets than liabilities. And we liked the look of last year's 57% year-on-year EBIT growth. So is Otsuka Holdings's debt a risk? It doesn't seem so to us. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. To that end, you should be aware of the 1 warning sign we've spotted with Otsuka Holdings .

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.