Tokyu Fudosan Holdings (TSE:3289) Use Of Debt Could Be Considered Risky

Warren Buffett famously said, '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. As with many other companies Tokyu Fudosan Holdings Corporation (TSE:3289) makes use of debt. But is this debt a concern to shareholders?

Why Does Debt Bring Risk?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. 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.

View our latest analysis for Tokyu Fudosan Holdings

What Is Tokyu Fudosan Holdings's Debt?

The chart below, which you can click on for greater detail, shows that Tokyu Fudosan Holdings had JP¥1.58t in debt in June 2024; about the same as the year before. However, because it has a cash reserve of JP¥164.7b, its net debt is less, at about JP¥1.42t.

How Strong Is Tokyu Fudosan Holdings' Balance Sheet?

According to the last reported balance sheet, Tokyu Fudosan Holdings had liabilities of JP¥430.0b due within 12 months, and liabilities of JP¥1.72t due beyond 12 months. Offsetting these obligations, it had cash of JP¥164.7b as well as receivables valued at JP¥42.2b due within 12 months. So its liabilities total JP¥1.95t more than the combination of its cash and short-term receivables.

This deficit casts a shadow over the JP¥687.3b company, like a colossus towering over mere mortals. So we'd watch its balance sheet closely, without a doubt. After all, Tokyu Fudosan Holdings would likely require a major re-capitalisation if it had to pay its creditors today.

We use two main ratios to inform us about debt levels relative to earnings. The first is net debt divided by earnings before interest, tax, depreciation, and amortization (EBITDA), while the second is how many times its earnings before interest and tax (EBIT) covers its interest expense (or its interest cover, for short). The advantage of this approach is that we take into account both the absolute quantum of debt (with net debt to EBITDA) and the actual interest expenses associated with that debt (with its interest cover ratio).

As it happens Tokyu Fudosan Holdings has a fairly concerning net debt to EBITDA ratio of 8.5 but very strong interest coverage of 10.7. This means that unless the company has access to very cheap debt, that interest expense will likely grow in the future. Sadly, Tokyu Fudosan Holdings's EBIT actually dropped 2.3% in the last year. If that earnings trend continues then its debt load will grow heavy like the heart of a polar bear watching its sole cub. 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 Tokyu Fudosan Holdings can strengthen its balance sheet over time. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So it's worth checking how much of that EBIT is backed by free cash flow. Considering the last three years, Tokyu Fudosan Holdings actually recorded a cash outflow, overall. Debt is usually more expensive, and almost always more risky in the hands of a company with negative free cash flow. Shareholders ought to hope for an improvement.

Our View

On the face of it, Tokyu Fudosan Holdings's net debt to EBITDA left us tentative about the stock, and its level of total liabilities was no more enticing than the one empty restaurant on the busiest night of the year. But at least it's pretty decent at covering its interest expense with its EBIT; that's encouraging. Overall, it seems to us that Tokyu Fudosan Holdings's balance sheet is really quite a risk to the business. So we're almost as wary of this stock as a hungry kitten is about falling into its owner's fish pond: once bitten, twice shy, as they say. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. To that end, you should learn about the 2 warning signs we've spotted with Tokyu Fudosan 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.

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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.