Tokyo Electric Power Company Holdings (TSE:9501) Use Of Debt Could Be Considered Risky

The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. As with many other companies Tokyo Electric Power Company Holdings, Incorporated (TSE:9501) makes use of debt. But should shareholders be worried about its use of debt?

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. 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. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. 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

What Is Tokyo Electric Power Company Holdings's Debt?

You can click the graphic below for the historical numbers, but it shows that as of December 2023 Tokyo Electric Power Company Holdings had JP¥6.29t of debt, an increase on JP¥5.71t, over one year. However, because it has a cash reserve of JP¥1.25t, its net debt is less, at about JP¥5.04t.

How Healthy 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¥4.27t falling due within a year, and liabilities of JP¥6.27t due beyond that. Offsetting these obligations, it had cash of JP¥1.25t as well as receivables valued at JP¥553.6b due within 12 months. So its liabilities total JP¥8.73t more than the combination of its cash and short-term receivables.

This deficit casts a shadow over the JP¥1.63t company, like a colossus towering over mere mortals. So we definitely think shareholders need to watch this one closely. After all, Tokyo Electric Power Company Holdings would likely require a major re-capitalisation if it had to pay its creditors today.

We measure a company's debt load relative to its earnings power by looking at its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and by calculating how easily its earnings before interest and tax (EBIT) cover its interest expense (interest cover). The advantage of this approach is that we take into account both the absolute quantum of debt (with net debt to EBITDA) and the actual interest expenses associated with that debt (with its interest cover ratio).

While Tokyo Electric Power Company Holdings's debt to EBITDA ratio of 7.1 suggests a heavy debt load, its interest coverage of 7.9 implies it services that debt with ease. Overall we'd say it seems likely the company is carrying a fairly heavy swag of debt. Notably, Tokyo Electric Power Company Holdings made a loss at the EBIT level, last year, but improved that to positive EBIT of JP¥427b in the last twelve months. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Tokyo Electric Power Company 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, a business needs free cash flow to pay off debt; accounting profits just don't cut it. 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, Tokyo Electric Power Company Holdings 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

On the face of it, Tokyo Electric Power Company Holdings's conversion of EBIT to free cash flow 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 it's pretty decent at covering its interest expense with its EBIT; that's encouraging. 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. Taking into account all the aforementioned factors, it looks like 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. 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 learn about the 4 warning signs we've spotted with Tokyo Electric Power Company Holdings (including 3 which don't sit too well with us) .

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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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.