Ota Floriculture AuctionLtd (TYO:7555) Is Making Moderate Use 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.' 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 Ota Floriculture Auction Co.,Ltd. (TYO:7555) makes use of debt. But is this debt a concern to shareholders?

What Risk Does Debt Bring?

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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, debt can be an important tool in businesses, particularly capital heavy businesses. When we examine debt levels, we first consider both cash and debt levels, together.

View our latest analysis for Ota Floriculture AuctionLtd

What Is Ota Floriculture AuctionLtd's Net Debt?

The image below, which you can click on for greater detail, shows that Ota Floriculture AuctionLtd had debt of JP¥1.73b at the end of September 2020, a reduction from JP¥2.10b over a year. However, it does have JP¥1.65b in cash offsetting this, leading to net debt of about JP¥81.0m.

How Strong Is Ota Floriculture AuctionLtd's Balance Sheet?

The latest balance sheet data shows that Ota Floriculture AuctionLtd had liabilities of JP¥1.84b due within a year, and liabilities of JP¥2.36b falling due after that. Offsetting these obligations, it had cash of JP¥1.65b as well as receivables valued at JP¥1.73b due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by JP¥824.0m.

While this might seem like a lot, it is not so bad since Ota Floriculture AuctionLtd has a market capitalization of JP¥3.67b, and so it could probably strengthen its balance sheet by raising capital if it needed to. However, it is still worthwhile taking a close look at its ability to pay off debt. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since Ota Floriculture AuctionLtd will need earnings to service that debt. So if you're keen to discover more about its earnings, it might be worth checking out this graph of its long term earnings trend.

In the last year Ota Floriculture AuctionLtd had a loss before interest and tax, and actually shrunk its revenue by 7.6%, to JP¥24b. That's not what we would hope to see.

Caveat Emptor

Importantly, Ota Floriculture AuctionLtd had an earnings before interest and tax (EBIT) loss over the last year. Indeed, it lost JP¥94m at the EBIT level. Considering that alongside the liabilities mentioned above does not give us much confidence that company should be using so much debt. Quite frankly we think the balance sheet is far from match-fit, although it could be improved with time. We would feel better if it turned its trailing twelve month loss of JP¥54m into a profit. So in short it's a really risky stock. 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. To that end, you should learn about the 3 warning signs we've spotted with Ota Floriculture AuctionLtd (including 1 which is can't be ignored) .

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

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