Is TakachihoLtd (TYO:8225) Using Debt In A Risky Way?

Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that '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. Importantly, Takachiho Co.,Ltd. (TYO:8225) does carry debt. But the more important question is: how much risk is that debt creating?

What Risk Does Debt Bring?

Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we think about a company's use of debt, we first look at cash and debt together.

See our latest analysis for TakachihoLtd

How Much Debt Does TakachihoLtd Carry?

As you can see below, at the end of September 2020, TakachihoLtd had JP¥2.23b of debt, up from JP¥1.43b a year ago. Click the image for more detail. However, it does have JP¥1.04b in cash offsetting this, leading to net debt of about JP¥1.19b.

A Look At TakachihoLtd's Liabilities

The latest balance sheet data shows that TakachihoLtd had liabilities of JP¥1.07b due within a year, and liabilities of JP¥2.04b falling due after that. Offsetting this, it had JP¥1.04b in cash and JP¥424.0m in receivables that were due within 12 months. So it has liabilities totalling JP¥1.65b more than its cash and near-term receivables, combined.

This deficit casts a shadow over the JP¥763.7m company, like a colossus towering over mere mortals. So we definitely think shareholders need to watch this one closely. At the end of the day, TakachihoLtd would probably need a major re-capitalization if its creditors were to demand repayment. The balance sheet is clearly the area to focus on when you are analysing debt. But you can't view debt in total isolation; since TakachihoLtd 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.

Over 12 months, TakachihoLtd made a loss at the EBIT level, and saw its revenue drop to JP¥5.6b, which is a fall of 45%. That makes us nervous, to say the least.

Caveat Emptor

Not only did TakachihoLtd's revenue slip over the last twelve months, but it also produced negative earnings before interest and tax (EBIT). Its EBIT loss was a whopping JP¥673m. Considering that alongside the liabilities mentioned above make us nervous about the company. It would need to improve its operations quickly for us to be interested in it. Not least because it burned through JP¥157m in negative free cash flow over the last year. That means it's on the risky side of things. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. We've identified 4 warning signs with TakachihoLtd (at least 3 which can't be ignored) , and understanding them should be part of your investment process.

When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.

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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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