Is Hankyu Hanshin Holdings (TSE:9042) A Risky Investment?

Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' 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, Hankyu Hanshin Holdings, Inc. (TSE:9042) does carry debt. But the more important question is: how much risk is that debt creating?

When Is Debt A Problem?

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. 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 think about a company's use of debt, we first look at cash and debt together.

Check out our latest analysis for Hankyu Hanshin Holdings

How Much Debt Does Hankyu Hanshin Holdings Carry?

The image below, which you can click on for greater detail, shows that at June 2024 Hankyu Hanshin Holdings had debt of JP¥1.19t, up from JP¥1.09t in one year. However, because it has a cash reserve of JP¥63.0b, its net debt is less, at about JP¥1.13t.

How Healthy Is Hankyu Hanshin Holdings' Balance Sheet?

We can see from the most recent balance sheet that Hankyu Hanshin Holdings had liabilities of JP¥489.9b falling due within a year, and liabilities of JP¥1.47t due beyond that. On the other hand, it had cash of JP¥63.0b and JP¥82.3b worth of receivables due within a year. So its liabilities total JP¥1.82t more than the combination of its cash and short-term receivables.

This deficit casts a shadow over the JP¥986.6b company, like a colossus towering over mere mortals. So we'd watch its balance sheet closely, without a doubt. After all, Hankyu Hanshin Holdings would likely require a major re-capitalisation if it had to pay its creditors today.

We use two main ratios to inform us about debt levels relative to earnings. The first is net debt divided by earnings before interest, tax, depreciation, and amortization (EBITDA), while the second is how many times its earnings before interest and tax (EBIT) covers its interest expense (or its interest cover, for short). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

As it happens Hankyu Hanshin Holdings has a fairly concerning net debt to EBITDA ratio of 6.6 but very strong interest coverage of 12.0. So either it has access to very cheap long term debt or that interest expense is going to grow! Hankyu Hanshin Holdings grew its EBIT by 7.4% in the last year. That's far from incredible but it is a good thing, when it comes to paying off debt. There's no doubt that we learn most about debt from the balance sheet. But it is future earnings, more than anything, that will determine Hankyu Hanshin Holdings's ability to maintain a healthy balance sheet going forward. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So we always check how much of that EBIT is translated into free cash flow. Over the last three years, Hankyu Hanshin Holdings reported free cash flow worth 2.3% of its EBIT, which is really quite low. For us, cash conversion that low sparks a little paranoia about is ability to extinguish debt.

Our View

On the face of it, Hankyu Hanshin Holdings's net debt to EBITDA left us tentative about the stock, and its level of total liabilities 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. Overall, it seems to us that Hankyu Hanshin Holdings's balance sheet is really quite a risk to the business. So we're almost as wary of this stock as a hungry kitten is about falling into its owner's fish pond: once bitten, twice shy, as they say. 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. These risks can be hard to spot. Every company has them, and we've spotted 2 warning signs for Hankyu Hanshin Holdings (of which 1 is a bit unpleasant!) you should know about.

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.