Chugoku Electric Power (TSE:9504) Seems To Be Using A Lot Of Debt

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.' 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. We note that The Chugoku Electric Power Co., Inc. (TSE:9504) does have debt on its balance sheet. But is this debt a concern to shareholders?

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. 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 step when considering a company's debt levels is to consider its cash and debt together.

View our latest analysis for Chugoku Electric Power

What Is Chugoku Electric Power's Debt?

As you can see below, Chugoku Electric Power had JP¥3.10t of debt, at September 2024, which is about the same as the year before. You can click the chart for greater detail. However, because it has a cash reserve of JP¥292.3b, its net debt is less, at about JP¥2.81t.

A Look At Chugoku Electric Power's Liabilities

Zooming in on the latest balance sheet data, we can see that Chugoku Electric Power had liabilities of JP¥703.5b due within 12 months and liabilities of JP¥2.93t due beyond that. Offsetting this, it had JP¥292.3b in cash and JP¥132.9b in receivables that were due within 12 months. So its liabilities total JP¥3.21t more than the combination of its cash and short-term receivables.

This deficit casts a shadow over the JP¥337.2b company, like a colossus towering over mere mortals. So we definitely think shareholders need to watch this one closely. After all, Chugoku Electric Power 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). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

Strangely Chugoku Electric Power has a sky high EBITDA ratio of 12.8, implying high debt, but a strong interest coverage of 11.1. This means that unless the company has access to very cheap debt, that interest expense will likely grow in the future. Shareholders should be aware that Chugoku Electric Power's EBIT was down 34% last year. If that decline continues then paying off debt will be harder than selling foie gras at a vegan convention. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Chugoku Electric Power'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 clearly need to look at whether that EBIT is leading to corresponding free cash flow. During the last two years, Chugoku Electric Power burned a lot of cash. While investors are no doubt expecting a reversal of that situation in due course, it clearly does mean its use of debt is more risky.

Our View

To be frank both Chugoku Electric Power's EBIT growth rate and its track record of staying on top of its total liabilities make us rather uncomfortable with its debt levels. But on the bright side, its interest cover is a good sign, and makes us more optimistic. We should also note that Electric Utilities industry companies like Chugoku Electric Power commonly do use debt without problems. After considering the datapoints discussed, we think Chugoku Electric Power has too much debt. That sort of riskiness is ok for some, but it certainly doesn't float our boat. 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. For instance, we've identified 1 warning sign for Chugoku Electric Power that you should be aware of.

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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

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.