Here's Why Hokuriku Electric Power (TSE:9505) Can Manage Its Debt Responsibly

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.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. We can see that Hokuriku Electric Power Company (TSE:9505) does use debt in its business. But should shareholders be worried about its use of debt?

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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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. 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. The first step when considering a company's debt levels is to consider its cash and debt together.

See our latest analysis for Hokuriku Electric Power

What Is Hokuriku Electric Power's Net Debt?

The chart below, which you can click on for greater detail, shows that Hokuriku Electric Power had JP¥1.16t in debt in December 2024; about the same as the year before. However, it also had JP¥197.5b in cash, and so its net debt is JP¥960.8b.

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A Look At Hokuriku Electric Power's Liabilities

We can see from the most recent balance sheet that Hokuriku Electric Power had liabilities of JP¥297.0b falling due within a year, and liabilities of JP¥1.16t due beyond that. Offsetting this, it had JP¥197.5b in cash and JP¥100.4b in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by JP¥1.16t.

This deficit casts a shadow over the JP¥197.3b 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, Hokuriku Electric Power 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.

Strangely Hokuriku Electric Power has a sky high EBITDA ratio of 5.8, implying high debt, but a strong interest coverage of 16.4. This means that unless the company has access to very cheap debt, that interest expense will likely grow in the future. We note that Hokuriku Electric Power grew its EBIT by 22% in the last year, and that should make it easier to pay down debt, going forward. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Hokuriku 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, a company can only pay off debt with cold hard cash, not accounting profits. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. Over the last two years, Hokuriku Electric Power recorded free cash flow worth a fulsome 91% of its EBIT, which is stronger than we'd usually expect. That positions it well to pay down debt if desirable to do so.

Our View

We weren't impressed with Hokuriku Electric Power's net debt to EBITDA, and its level of total liabilities made us cautious. But like a ballerina ending on a perfect pirouette, it has not trouble covering its interest expense with its EBIT. We would also note that Electric Utilities industry companies like Hokuriku Electric Power commonly do use debt without problems. When we consider all the factors mentioned above, we do feel a bit cautious about Hokuriku Electric Power's use of debt. While debt does have its upside in higher potential returns, we think shareholders should definitely consider how debt levels might make the stock more risky. 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 4 warning signs for Hokuriku Electric Power (2 are concerning!) 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.