Health Check: How Prudently Does Ota Floriculture AuctionLtd (TYO:7555) Use Debt?

Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. We note that Ota Floriculture Auction Co.,Ltd. (TYO:7555) does have debt on its balance sheet. But the more important question is: how much risk is that debt creating?

When Is Debt Dangerous?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. 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.

Check out our latest analysis for Ota Floriculture AuctionLtd

What Is Ota Floriculture AuctionLtd's Debt?

The image below, which you can click on for greater detail, shows that Ota Floriculture AuctionLtd had debt of JP¥1.67b at the end of December 2020, a reduction from JP¥2.04b over a year. However, its balance sheet shows it holds JP¥2.04b in cash, so it actually has JP¥374.0m net cash.

How Healthy Is Ota Floriculture AuctionLtd's Balance Sheet?

The latest balance sheet data shows that Ota Floriculture AuctionLtd had liabilities of JP¥2.74b due within a year, and liabilities of JP¥2.31b falling due after that. On the other hand, it had cash of JP¥2.04b and JP¥2.34b worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by JP¥666.0m.

Given Ota Floriculture AuctionLtd has a market capitalization of JP¥3.85b, it's hard to believe these liabilities pose much threat. Having said that, it's clear that we should continue to monitor its balance sheet, lest it change for the worse. Despite its noteworthy liabilities, Ota Floriculture AuctionLtd boasts net cash, so it's fair to say it does not have a heavy debt load! The balance sheet is clearly the area to focus on when you are analysing debt. But it is Ota Floriculture AuctionLtd's earnings that will influence how the balance sheet holds up in the future. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

In the last year Ota Floriculture AuctionLtd had a loss before interest and tax, and actually shrunk its revenue by 7.2%, to JP¥24b. That's not what we would hope to see.

So How Risky Is Ota Floriculture AuctionLtd?

While Ota Floriculture AuctionLtd lost money on an earnings before interest and tax (EBIT) level, it actually generated positive free cash flow JP¥367m. So although it is loss-making, it doesn't seem to have too much near-term balance sheet risk, keeping in mind the net cash. Until we see some positive EBIT, we're a bit cautious of the stock, not least because of the rather modest revenue growth. 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. For example Ota Floriculture AuctionLtd has 3 warning signs (and 1 which is a bit concerning) we think you should know about.

If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.

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This article by Simply Wall St is general in nature. 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.
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