Does Tokyo Electric Power Company Holdings (TSE:9501) Have A Healthy Balance Sheet?

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. As with many other companies Tokyo Electric Power Company Holdings, Incorporated (TSE:9501) makes use of debt. But the more important question is: how much risk is that debt creating?

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we think about a company's use of debt, we first look at cash and debt together.

View our latest analysis for Tokyo Electric Power Company Holdings

How Much Debt Does Tokyo Electric Power Company Holdings Carry?

The image below, which you can click on for greater detail, shows that at June 2024 Tokyo Electric Power Company Holdings had debt of JP¥6.45t, up from JP¥6.12t in one year. However, it does have JP¥977.0b in cash offsetting this, leading to net debt of about JP¥5.47t.

How Strong Is Tokyo Electric Power Company Holdings' Balance Sheet?

We can see from the most recent balance sheet that Tokyo Electric Power Company Holdings had liabilities of JP¥4.49t falling due within a year, and liabilities of JP¥6.33t due beyond that. On the other hand, it had cash of JP¥977.0b and JP¥578.1b worth of receivables due within a year. So its liabilities total JP¥9.27t more than the combination of its cash and short-term receivables.

This deficit casts a shadow over the JP¥1.09t company, like a colossus towering over mere mortals. So we definitely think shareholders need to watch this one closely. At the end of the day, Tokyo Electric Power Company Holdings would probably need a major re-capitalization if its creditors were to demand repayment.

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). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

Tokyo Electric Power Company Holdings has a rather high debt to EBITDA ratio of 9.9 which suggests a meaningful debt load. However, its interest coverage of 3.3 is reasonably strong, which is a good sign. However, the silver lining was that Tokyo Electric Power Company Holdings achieved a positive EBIT of JP¥191b in the last twelve months, an improvement on the prior year's loss. There's no doubt that we learn most about debt from the balance sheet. But ultimately the future profitability of the business will decide if Tokyo Electric Power Company Holdings can strengthen its balance sheet over time. 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 business needs free cash flow to pay off debt; accounting profits just don't cut it. So it is important to check how much of its earnings before interest and tax (EBIT) converts to actual free cash flow. Over the last year, Tokyo Electric Power Company 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.

Our View

On the face of it, Tokyo Electric Power Company 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 at least its EBIT growth rate is not so bad. It's also worth noting that Tokyo Electric Power Company Holdings is in the Electric Utilities industry, which is often considered to be quite defensive. After considering the datapoints discussed, we think Tokyo Electric Power Company Holdings has too much debt. While some investors love that sort of risky play, it's certainly not our cup of tea. 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. For example, we've discovered 2 warning signs for Tokyo Electric Power Company Holdings (1 is potentially serious!) that you should be aware of before investing here.

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.