Tokyo Tatemono (TSE:8804) Seems To Be Using A Lot Of 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 Tokyo Tatemono Co., Ltd. (TSE:8804) 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 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. Of course, plenty of companies use debt to fund growth, without any negative consequences. When we examine debt levels, we first consider both cash and debt levels, together.

View our latest analysis for Tokyo Tatemono

How Much Debt Does Tokyo Tatemono Carry?

As you can see below, at the end of December 2024, Tokyo Tatemono had JP¥1.21t of debt, up from JP¥1.09t a year ago. Click the image for more detail. However, because it has a cash reserve of JP¥111.1b, its net debt is less, at about JP¥1.10t.

How Healthy Is Tokyo Tatemono's Balance Sheet?

We can see from the most recent balance sheet that Tokyo Tatemono had liabilities of JP¥297.8b falling due within a year, and liabilities of JP¥1.24t due beyond that. Offsetting these obligations, it had cash of JP¥111.1b as well as receivables valued at JP¥15.0b due within 12 months. So its liabilities total JP¥1.41t more than the combination of its cash and short-term receivables.

This deficit casts a shadow over the JP¥508.6b company, like a colossus towering over mere mortals. So we'd watch its balance sheet closely, without a doubt. At the end of the day, Tokyo Tatemono would probably need a major re-capitalization if its creditors were to demand repayment.

In order to size up a company's debt relative to its earnings, we calculate its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and its earnings before interest and tax (EBIT) divided by its interest expense (its interest cover). 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 Tokyo Tatemono has a fairly concerning net debt to EBITDA ratio of 10.7 but very strong interest coverage of 17.4. This means that unless the company has access to very cheap debt, that interest expense will likely grow in the future. If Tokyo Tatemono can keep growing EBIT at last year's rate of 13% over the last year, then it will find its debt load easier to manage. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Tokyo Tatemono's ability to maintain a healthy balance sheet going forward. 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. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. Over the last three years, Tokyo Tatemono saw substantial negative free cash flow, in total. While investors are no doubt expecting a reversal of that situation in due course, it clearly does mean its use of debt is more risky.

Our View

To be frank both Tokyo Tatemono's conversion of EBIT to free cash flow and its track record of staying on top of its total liabilities make us rather uncomfortable with its debt levels. But at least it's pretty decent at covering its interest expense with its EBIT; that's encouraging. We're quite clear that we consider Tokyo Tatemono to be really rather risky, as a result of its balance sheet health. 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. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. Be aware that Tokyo Tatemono is showing 4 warning signs in our investment analysis , and 2 of those are significant...

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.