Does Odakyu Electric Railway (TSE:9007) Have A Healthy Balance Sheet?

Warren Buffett famously said, 'Volatility is far from synonymous with risk.' 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. Importantly, Odakyu Electric Railway Co., Ltd. (TSE:9007) does carry debt. But is this debt a concern to shareholders?

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. If things get really bad, the lenders can take control of the business. 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. When we examine debt levels, we first consider both cash and debt levels, together.

See our latest analysis for Odakyu Electric Railway

What Is Odakyu Electric Railway's Debt?

The image below, which you can click on for greater detail, shows that Odakyu Electric Railway had debt of JP¥559.8b at the end of June 2024, a reduction from JP¥652.6b over a year. However, it does have JP¥22.5b in cash offsetting this, leading to net debt of about JP¥537.3b.

How Strong Is Odakyu Electric Railway's Balance Sheet?

According to the last reported balance sheet, Odakyu Electric Railway had liabilities of JP¥328.4b due within 12 months, and liabilities of JP¥438.6b due beyond 12 months. Offsetting this, it had JP¥22.5b in cash and JP¥22.1b in receivables that were due within 12 months. So its liabilities total JP¥722.4b more than the combination of its cash and short-term receivables.

When you consider that this deficiency exceeds the company's JP¥561.6b market capitalization, you might well be inclined to review the balance sheet intently. In the scenario where the company had to clean up its balance sheet quickly, it seems likely shareholders would suffer extensive 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.

As it happens Odakyu Electric Railway has a fairly concerning net debt to EBITDA ratio of 5.5 but very strong interest coverage of 18.9. So either it has access to very cheap long term debt or that interest expense is going to grow! It is well worth noting that Odakyu Electric Railway's EBIT shot up like bamboo after rain, gaining 56% in the last twelve months. That'll make it easier to manage its debt. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Odakyu Electric Railway's ability to maintain a healthy balance sheet going forward. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. So we always check how much of that EBIT is translated into free cash flow. Over the last three years, Odakyu Electric Railway reported free cash flow worth 8.6% of its EBIT, which is really quite low. That limp level of cash conversion undermines its ability to manage and pay down debt.

Our View

On the face of it, Odakyu Electric Railway's level of total liabilities left us tentative about the stock, and its net debt to EBITDA was no more enticing than the one empty restaurant on the busiest night of the year. 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 Odakyu Electric Railway stock a bit risky. Some people like that sort of risk, but we're mindful of the potential pitfalls, so we'd probably prefer it carry less debt. 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 instance, we've identified 4 warning signs for Odakyu Electric Railway (2 can't be ignored) you should be aware of.

If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.

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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.