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

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. We can see that Otsuka Holdings Co., Ltd. (TSE:4578) does use debt in its business. But should shareholders be worried about its use of debt?

What Risk Does Debt Bring?

Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. When we think about a company's use of debt, we first look at cash and debt together.

View our latest analysis for Otsuka Holdings

What Is Otsuka Holdings's Net Debt?

The image below, which you can click on for greater detail, shows that at June 2024 Otsuka Holdings had debt of JP¥166.5b, up from JP¥114.1b in one year. However, it does have JP¥485.9b in cash offsetting this, leading to net cash of JP¥319.4b.

A Look At Otsuka Holdings' Liabilities

We can see from the most recent balance sheet that Otsuka Holdings had liabilities of JP¥723.8b falling due within a year, and liabilities of JP¥270.0b due beyond that. On the other hand, it had cash of JP¥485.9b and JP¥535.4b worth of receivables due within a year. So it can boast JP¥27.4b more liquid assets than total liabilities.

Having regard to Otsuka Holdings' size, it seems that its liquid assets are well balanced with its total liabilities. So while it's hard to imagine that the JP¥4.59t company is struggling for cash, we still think it's worth monitoring its balance sheet. Simply put, the fact that Otsuka Holdings has more cash than debt is arguably a good indication that it can manage its debt safely.

On top of that, Otsuka Holdings grew its EBIT by 54% over the last twelve months, and that growth will make it easier to handle its debt. 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.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. 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. Looking at the most recent three years, Otsuka Holdings recorded free cash flow of 27% of its EBIT, which is weaker than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.

Summing Up

While we empathize with investors who find debt concerning, you should keep in mind that Otsuka Holdings has net cash of JP¥319.4b, as well as more liquid assets than liabilities. And we liked the look of last year's 54% year-on-year EBIT growth. So is Otsuka Holdings's debt a risk? It doesn't seem so to us. 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 Otsuka Holdings is showing 2 warning signs in our investment analysis , 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.

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.