Is MINATO HOLDINGS (TYO:6862) Using Too Much Debt?

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.' 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. We can see that MINATO HOLDINGS INC. (TYO:6862) does use debt in its business. But the real question is whether this debt is making the company risky.

Why Does Debt Bring Risk?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. 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.

View our latest analysis for MINATO HOLDINGS

How Much Debt Does MINATO HOLDINGS Carry?

As you can see below, at the end of December 2020, MINATO HOLDINGS had JP¥5.99b of debt, up from JP¥5.03b a year ago. Click the image for more detail. On the flip side, it has JP¥2.27b in cash leading to net debt of about JP¥3.72b.

A Look At MINATO HOLDINGS' Liabilities

We can see from the most recent balance sheet that MINATO HOLDINGS had liabilities of JP¥6.60b falling due within a year, and liabilities of JP¥2.36b due beyond that. Offsetting this, it had JP¥2.27b in cash and JP¥3.36b in receivables that were due within 12 months. So it has liabilities totalling JP¥3.32b more than its cash and near-term receivables, combined.

This is a mountain of leverage relative to its market capitalization of JP¥3.49b. Should its lenders demand that it shore up the balance sheet, shareholders would likely face severe dilution.

In order to size up a company's debt relative to its earnings, we calculate its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and its earnings before interest and tax (EBIT) divided by its interest expense (its interest cover). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

MINATO HOLDINGS has a rather high debt to EBITDA ratio of 11.7 which suggests a meaningful debt load. But the good news is that it boasts fairly comforting interest cover of 6.7 times, suggesting it can responsibly service its obligations. Importantly, MINATO HOLDINGS's EBIT fell a jaw-dropping 33% in the last twelve months. If that decline continues then paying off debt will be harder than selling foie gras at a vegan convention. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since MINATO HOLDINGS will need earnings to service that debt. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. So the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. Happily for any shareholders, MINATO HOLDINGS actually produced more free cash flow than EBIT over the last three years. That sort of strong cash generation warms our hearts like a puppy in a bumblebee suit.

Our View

On the face of it, MINATO HOLDINGS's net debt to EBITDA left us tentative about the stock, and its EBIT growth rate was no more enticing than the one empty restaurant on the busiest night of the year. But at least it's pretty decent at converting EBIT to free cash flow; that's encouraging. Once we consider all the factors above, together, it seems to us that MINATO HOLDINGS's debt is making it 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. But ultimately, every company can contain risks that exist outside of the balance sheet. Be aware that MINATO HOLDINGS is showing 4 warning signs in our investment analysis , and 1 of those can't be ignored...

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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