Is Tohoku Electric Power Company (TSE:9506) A Risky Investment?

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.' 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 Tohoku Electric Power Company, Incorporated (TSE:9506) does use debt in its business. But the real question is whether this debt is making the company risky.

We've discovered 4 warning signs about Tohoku Electric Power Company. View them for free.

Why Does Debt Bring Risk?

Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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. 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 thing to do when considering how much debt a business uses is to look at its cash and debt together.

What Is Tohoku Electric Power Company's Net Debt?

As you can see below, Tohoku Electric Power Company had JP¥3.40t of debt, at December 2024, which is about the same as the year before. You can click the chart for greater detail. However, it does have JP¥514.7b in cash offsetting this, leading to net debt of about JP¥2.89t.

How Healthy Is Tohoku Electric Power Company's Balance Sheet?

The latest balance sheet data shows that Tohoku Electric Power Company had liabilities of JP¥1.17t due within a year, and liabilities of JP¥3.27t falling due after that. Offsetting these obligations, it had cash of JP¥514.7b as well as receivables valued at JP¥240.3b due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by JP¥3.68t.

This deficit casts a shadow over the JP¥497.5b company, like a colossus towering over mere mortals. So we definitely think shareholders need to watch this one closely. After all, Tohoku Electric Power Company would likely require a major re-capitalisation if it had to pay its creditors today.

Check out our latest analysis for Tohoku Electric Power Company

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). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

While Tohoku Electric Power Company's debt to EBITDA ratio of 6.8 suggests a heavy debt load, its interest coverage of 9.9 implies it services that debt with ease. Overall we'd say it seems likely the company is carrying a fairly heavy swag of debt. Shareholders should be aware that Tohoku Electric Power Company's EBIT was down 29% 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 ultimately the future profitability of the business will decide if Tohoku Electric Power Company can strengthen its balance sheet over time. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So it's worth checking how much of that EBIT is backed by free cash flow. Over the last two years, Tohoku Electric Power Company reported free cash flow worth 9.3% of its EBIT, which is really quite low. For us, cash conversion that low sparks a little paranoia about is ability to extinguish debt.

Our View

To be frank both Tohoku Electric Power Company'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 at least it's pretty decent at covering its interest expense with its EBIT; that's encouraging. It's also worth noting that Tohoku Electric Power Company is in the Electric Utilities industry, which is often considered to be quite defensive. Taking into account all the aforementioned factors, it looks like Tohoku Electric Power Company 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. However, not all investment risk resides within the balance sheet - far from it. For example, we've discovered 4 warning signs for Tohoku Electric Power Company (2 can't be ignored!) that you should be aware of before investing here.

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.

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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.