These 4 Measures Indicate That K's Holdings (TSE:8282) Is Using Debt Extensively

David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the permanent loss of capital.' 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. Importantly, K's Holdings Corporation (TSE:8282) does carry debt. But should shareholders be worried about its use of debt?

When Is Debt Dangerous?

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. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. The first step when considering a company's debt levels is to consider its cash and debt together.

Check out our latest analysis for K's Holdings

What Is K's Holdings's Debt?

As you can see below, at the end of December 2023, K's Holdings had JP¥50.4b of debt, up from JP¥48.1b a year ago. Click the image for more detail. However, it also had JP¥15.4b in cash, and so its net debt is JP¥35.0b.

How Healthy Is K's Holdings' Balance Sheet?

The latest balance sheet data shows that K's Holdings had liabilities of JP¥163.3b due within a year, and liabilities of JP¥25.3b falling due after that. Offsetting these obligations, it had cash of JP¥15.4b as well as receivables valued at JP¥32.3b due within 12 months. So its liabilities total JP¥140.9b more than the combination of its cash and short-term receivables.

This deficit is considerable relative to its market capitalization of JP¥226.2b, so it does suggest shareholders should keep an eye on K's Holdings' use of debt. This suggests shareholders would be heavily diluted if the company needed to shore up its balance sheet in a hurry.

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). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

K's Holdings has a low net debt to EBITDA ratio of only 0.94. And its EBIT easily covers its interest expense, being 152 times the size. So we're pretty relaxed about its super-conservative use of debt. In fact K's Holdings's saving grace is its low debt levels, because its EBIT has tanked 33% in the last twelve months. Falling earnings (if the trend continues) could eventually make even modest debt quite risky. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine K's Holdings's ability to maintain a healthy balance sheet going forward. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So it's worth checking how much of that EBIT is backed by free cash flow. In the last three years, K's Holdings's free cash flow amounted to 25% of its EBIT, less 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 K's Holdings's EBIT growth rate was disappointing. But on the bright side, its interest cover is a good sign, and makes us more optimistic. Looking at the balance sheet and taking into account all these factors, we do believe that debt is making K's Holdings stock a bit risky. That's not necessarily a bad thing, but we'd generally feel more comfortable with less leverage. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. For example - K's Holdings has 1 warning sign we think you should be aware of.

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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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.