Is Otsuka (TSE:4768) Using Too Much Debt?

The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. As with many other companies Otsuka Corporation (TSE:4768) makes use of debt. But should shareholders be worried about its use of debt?

Why Does Debt Bring Risk?

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. 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. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

How Much Debt Does Otsuka Carry?

As you can see below, Otsuka had JP¥6.00b of debt, at December 2024, which is about the same as the year before. You can click the chart for greater detail. But on the other hand it also has JP¥228.1b in cash, leading to a JP¥222.1b net cash position.

How Strong Is Otsuka's Balance Sheet?

The latest balance sheet data shows that Otsuka had liabilities of JP¥289.7b due within a year, and liabilities of JP¥8.97b falling due after that. On the other hand, it had cash of JP¥228.1b and JP¥200.8b worth of receivables due within a year. So it actually has JP¥130.3b more liquid assets than total liabilities.

This short term liquidity is a sign that Otsuka could probably pay off its debt with ease, as its balance sheet is far from stretched. Simply put, the fact that Otsuka has more cash than debt is arguably a good indication that it can manage its debt safely.

View our latest analysis for Otsuka

Also good is that Otsuka grew its EBIT at 18% over the last year, further increasing its ability to manage debt. There's no doubt that we learn most about debt from the balance sheet. But ultimately the future profitability of the business will decide if Otsuka can strengthen its balance sheet over time. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. Otsuka may have net cash on the balance sheet, but it is still interesting to look at how well the business converts its earnings before interest and tax (EBIT) to free cash flow, because that will influence both its need for, and its capacity to manage debt. Over the most recent three years, Otsuka recorded free cash flow worth 57% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This free cash flow puts the company in a good position to pay down debt, when appropriate.

Summing Up

While we empathize with investors who find debt concerning, you should keep in mind that Otsuka has net cash of JP¥222.1b, as well as more liquid assets than liabilities. And it impressed us with its EBIT growth of 18% over the last year. So we don't think Otsuka's use of debt is risky. 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. To that end, you should learn about the 2 warning signs we've spotted with Otsuka (including 1 which is concerning) .

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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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.