Here's Why Koryojyuhan (TYO:3495) Has A Meaningful Debt Burden

Warren Buffett famously said, 'Volatility is far from synonymous with risk.' 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 Koryojyuhan Co., Ltd. (TYO:3495) makes use of debt. But should shareholders be worried about its use of debt?

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. If things get really bad, the lenders can take control of the business. 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. When we examine debt levels, we first consider both cash and debt levels, together.

View our latest analysis for Koryojyuhan

How Much Debt Does Koryojyuhan Carry?

You can click the graphic below for the historical numbers, but it shows that Koryojyuhan had JP¥3.26b of debt in September 2020, down from JP¥3.89b, one year before. However, it also had JP¥1.66b in cash, and so its net debt is JP¥1.60b.

How Strong Is Koryojyuhan's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Koryojyuhan had liabilities of JP¥2.44b due within 12 months and liabilities of JP¥3.35b due beyond that. On the other hand, it had cash of JP¥1.66b and JP¥151.0m worth of receivables due within a year. So it has liabilities totalling JP¥3.98b more than its cash and near-term receivables, combined.

The deficiency here weighs heavily on the JP¥2.05b company itself, as if a child were struggling under the weight of an enormous back-pack full of books, his sports gear, and a trumpet. So we'd watch its balance sheet closely, without a doubt. At the end of the day, Koryojyuhan would probably need a major re-capitalization if its creditors were to demand repayment.

We measure a company's debt load relative to its earnings power by looking at its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and by calculating how easily its earnings before interest and tax (EBIT) cover its interest expense (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).

We'd say that Koryojyuhan's moderate net debt to EBITDA ratio ( being 1.9), indicates prudence when it comes to debt. And its commanding EBIT of 21.4 times its interest expense, implies the debt load is as light as a peacock feather. Sadly, Koryojyuhan's EBIT actually dropped 3.6% in the last year. If earnings continue on that decline then managing that debt will be difficult like delivering hot soup on a unicycle. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Koryojyuhan'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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. Looking at the most recent three years, Koryojyuhan recorded free cash flow of 29% of its EBIT, which is weaker than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.

Our View

We'd go so far as to say Koryojyuhan's level of total liabilities was disappointing. But at least it's pretty decent at covering its interest expense with its EBIT; that's encouraging. Looking at the bigger picture, it seems clear to us that Koryojyuhan's use of debt is creating risks for the company. If all goes well, that should boost returns, but on the flip side, the risk of permanent capital loss is elevated by the debt. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. Consider risks, for instance. Every company has them, and we've spotted 3 warning signs for Koryojyuhan you should know about.

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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