These 4 Measures Indicate That Hokuriku Electric Power (TSE:9505) Is Using Debt Extensively

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.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. We can see that Hokuriku Electric Power Company (TSE:9505) does use debt in its business. But the more important question is: how much risk is that debt creating?

Why Does Debt Bring Risk?

Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. Of course, plenty of companies use debt to fund growth, without any negative consequences. When we think about a company's use of debt, we first look at cash and debt together.

Check out our latest analysis for Hokuriku Electric Power

What Is Hokuriku Electric Power's Net Debt?

As you can see below, Hokuriku Electric Power had JP¥1.20t of debt at December 2023, down from JP¥1.30t a year prior. On the flip side, it has JP¥186.1b in cash leading to net debt of about JP¥1.01t.

How Strong Is Hokuriku Electric Power's Balance Sheet?

According to the last reported balance sheet, Hokuriku Electric Power had liabilities of JP¥250.5b due within 12 months, and liabilities of JP¥1.23t due beyond 12 months. On the other hand, it had cash of JP¥186.1b and JP¥76.6b worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by JP¥1.22t.

The deficiency here weighs heavily on the JP¥187.0b company itself, as if a child were struggling under the weight of an enormous back-pack full of books, his sports gear, and a trumpet. 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.

As it happens Hokuriku Electric Power has a fairly concerning net debt to EBITDA ratio of 6.9 but very strong interest coverage of 12.4. This means that unless the company has access to very cheap debt, that interest expense will likely grow in the future. Notably, Hokuriku Electric Power made a loss at the EBIT level, last year, but improved that to positive EBIT of JP¥84b in the last twelve months. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately the future profitability of the business will decide if Hokuriku Electric Power 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, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So it's worth checking how much of the earnings before interest and tax (EBIT) is backed by free cash flow. Considering the last year, Hokuriku Electric Power actually recorded a cash outflow, overall. Debt is far more risky for companies with unreliable free cash flow, so shareholders should be hoping that the past expenditure will produce free cash flow in the future.

Our View

To be frank both Hokuriku Electric Power's net debt to EBITDA 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 Hokuriku Electric Power commonly do use debt without problems. We're quite clear that we consider Hokuriku Electric Power to be really rather risky, as a result of its balance sheet health. 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. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. For example, we've discovered 2 warning signs for Hokuriku Electric Power that you should be aware of before investing here.

When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.

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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.