Is Otsuka Holdings (TSE:4578) Using Too Much 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.' 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 Otsuka Holdings Co., Ltd. (TSE:4578) does use debt in its business. But should shareholders be worried about its use of debt?

Why Does Debt Bring Risk?

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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. The first step when considering a company's debt levels is to consider its cash and debt together.

Check out our latest analysis for Otsuka Holdings

How Much Debt Does Otsuka Holdings Carry?

As you can see below, at the end of September 2024, Otsuka Holdings had JP¥258.9b of debt, up from JP¥111.2b a year ago. Click the image for more detail. However, its balance sheet shows it holds JP¥515.1b in cash, so it actually has JP¥256.2b net cash.

How Strong Is Otsuka Holdings' Balance Sheet?

We can see from the most recent balance sheet that Otsuka Holdings had liabilities of JP¥747.0b falling due within a year, and liabilities of JP¥299.7b due beyond that. On the other hand, it had cash of JP¥515.1b and JP¥475.5b worth of receivables due within a year. So its liabilities total JP¥56.1b more than the combination of its cash and short-term receivables.

This state of affairs indicates that Otsuka Holdings' balance sheet looks quite solid, as its total liabilities are just about equal to its liquid assets. So while it's hard to imagine that the JP¥4.37t company is struggling for cash, we still think it's worth monitoring its balance sheet. While it does have liabilities worth noting, Otsuka Holdings also has more cash than debt, so we're pretty confident it can manage its debt safely.

On top of that, Otsuka Holdings grew its EBIT by 49% 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 ultimately the future profitability of the business will decide if Otsuka Holdings 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. Otsuka 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, Otsuka Holdings's free cash flow amounted to 23% of its EBIT, less than we'd expect. That's not great, when it comes to paying down debt.

Summing Up

While it is always sensible to look at a company's total liabilities, it is very reassuring that Otsuka Holdings has JP¥256.2b in net cash. And we liked the look of last year's 49% 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. For example, we've discovered 1 warning sign for Otsuka Holdings that you should be aware of before investing here.

At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.

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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.