Here's Why Odawara Auto-Machine Mfg (TSE:7314) Has A Meaningful Debt Burden

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.' 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 Odawara Auto-Machine Mfg. Co., Ltd. (TSE:7314) does use debt in its business. 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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. 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.

Check out our latest analysis for Odawara Auto-Machine Mfg

What Is Odawara Auto-Machine Mfg's Debt?

The image below, which you can click on for greater detail, shows that at September 2024 Odawara Auto-Machine Mfg had debt of JP¥3.69b, up from JP¥300.0m in one year. However, because it has a cash reserve of JP¥3.06b, its net debt is less, at about JP¥626.0m.

How Strong Is Odawara Auto-Machine Mfg's Balance Sheet?

The latest balance sheet data shows that Odawara Auto-Machine Mfg had liabilities of JP¥5.34b due within a year, and liabilities of JP¥307.0m falling due after that. On the other hand, it had cash of JP¥3.06b and JP¥974.0m worth of receivables due within a year. So it has liabilities totalling JP¥1.62b more than its cash and near-term receivables, combined.

While this might seem like a lot, it is not so bad since Odawara Auto-Machine Mfg has a market capitalization of JP¥4.66b, and so it could probably strengthen its balance sheet by raising capital if it needed to. But it's clear that we should definitely closely examine whether it can manage its debt without 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.

Odawara Auto-Machine Mfg's net debt is only 0.66 times its EBITDA. And its EBIT covers its interest expense a whopping 80.1 times over. So we're pretty relaxed about its super-conservative use of debt. It was also good to see that despite losing money on the EBIT line last year, Odawara Auto-Machine Mfg turned things around in the last 12 months, delivering and EBIT of JP¥881m. When analysing debt levels, the balance sheet is the obvious place to start. But it is Odawara Auto-Machine Mfg'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, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So it's worth checking how much of the earnings before interest and tax (EBIT) is backed by free cash flow. Over the last year, Odawara Auto-Machine Mfg saw substantial negative free cash flow, in total. While that may be a result of expenditure for growth, it does make the debt far more risky.

Our View

Neither Odawara Auto-Machine Mfg's ability to convert EBIT to free cash flow nor its level of total liabilities gave us confidence in its ability to take on more debt. But the good news is it seems to be able to cover its interest expense with its EBIT with ease. We think that Odawara Auto-Machine Mfg's debt does make it a bit risky, after considering the aforementioned data points together. Not all risk is bad, as it can boost share price returns if it pays off, but this debt risk is worth keeping in mind. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. To that end, you should be aware of the 1 warning sign we've spotted with Odawara Auto-Machine Mfg .

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.