We Think Akiba Holdings (TYO:6840) Can Stay On Top Of Its 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.' 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. We note that Akiba Holdings Co., Ltd. (TYO:6840) 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 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. 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. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

See our latest analysis for Akiba Holdings

How Much Debt Does Akiba Holdings Carry?

As you can see below, at the end of September 2020, Akiba Holdings had JP¥3.54b of debt, up from JP¥2.94b a year ago. Click the image for more detail. But it also has JP¥3.58b in cash to offset that, meaning it has JP¥37.0m net cash.

How Strong Is Akiba Holdings's Balance Sheet?

According to the last reported balance sheet, Akiba Holdings had liabilities of JP¥4.37b due within 12 months, and liabilities of JP¥535.0m due beyond 12 months. Offsetting this, it had JP¥3.58b in cash and JP¥2.08b in receivables that were due within 12 months. So it can boast JP¥750.0m more liquid assets than total liabilities.

This surplus suggests that Akiba Holdings is using debt in a way that is appears to be both safe and conservative. Because it has plenty of assets, it is unlikely to have trouble with its lenders. Simply put, the fact that Akiba Holdings has more cash than debt is arguably a good indication that it can manage its debt safely.

On the other hand, Akiba Holdings's EBIT dived 11%, over the last year. We think hat kind of performance, if repeated frequently, could well lead to difficulties for the stock. The balance sheet is clearly the area to focus on when you are analysing debt. But it is Akiba Holdings'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.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. While Akiba Holdings has net cash on its balance sheet, it's still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. Over the last three years, Akiba Holdings recorded negative free cash flow, in total. Debt is usually more expensive, and almost always more risky in the hands of a company with negative free cash flow. Shareholders ought to hope for an improvement.

Summing up

While we empathize with investors who find debt concerning, you should keep in mind that Akiba Holdings has net cash of JP¥37.0m, as well as more liquid assets than liabilities. So we are not troubled with Akiba Holdings's debt use. 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. Case in point: We've spotted 3 warning signs for Akiba Holdings you should be aware of, and 1 of them is a bit concerning.

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

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