Does Hokkaido Electric Power Company (TSE:9509) Have A Healthy Balance Sheet?

Warren Buffett famously said, 'Volatility is far from synonymous with risk.' 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. We note that Hokkaido Electric Power Company, Incorporated (TSE:9509) does have debt on its balance sheet. But should shareholders be worried about its use of debt?

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When Is Debt Dangerous?

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 common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. Of course, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. The first step when considering a company's debt levels is to consider its cash and debt together.

How Much Debt Does Hokkaido Electric Power Company Carry?

As you can see below, Hokkaido Electric Power Company had JP¥1.40t of debt, at December 2024, which is about the same as the year before. You can click the chart for greater detail. On the flip side, it has JP¥129.7b in cash leading to net debt of about JP¥1.27t.

A Look At Hokkaido Electric Power Company's Liabilities

According to the last reported balance sheet, Hokkaido Electric Power Company had liabilities of JP¥422.6b due within 12 months, and liabilities of JP¥1.38t due beyond 12 months. Offsetting these obligations, it had cash of JP¥129.7b as well as receivables valued at JP¥115.3b due within 12 months. So its liabilities total JP¥1.56t more than the combination of its cash and short-term receivables.

The deficiency here weighs heavily on the JP¥129.7b 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. After all, Hokkaido Electric Power Company would likely require a major re-capitalisation if it had to pay its creditors today.

See our latest analysis for Hokkaido Electric Power Company

We use two main ratios to inform us about debt levels relative to earnings. The first is net debt divided by earnings before interest, tax, depreciation, and amortization (EBITDA), while the second is how many times its earnings before interest and tax (EBIT) covers its interest expense (or its interest cover, for short). 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 Hokkaido Electric Power Company's debt to EBITDA ratio of 8.3 suggests a heavy debt load, its interest coverage of 7.3 implies it services that debt with ease. Overall we'd say it seems likely the company is carrying a fairly heavy swag of debt. Importantly Hokkaido Electric Power Company's EBIT was essentially flat over the last twelve months. Ideally it can diminish its debt load by kick-starting earnings growth. The balance sheet is clearly the area to focus on when you are analysing debt. But it is future earnings, more than anything, that will determine Hokkaido Electric Power Company's ability to maintain a healthy balance sheet going forward. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. Looking at the most recent two years, Hokkaido Electric Power Company recorded free cash flow of 38% of its EBIT, which is weaker than we'd expect. That's not great, when it comes to paying down debt.

Our View

To be frank both Hokkaido Electric Power Company'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 at least it's pretty decent at covering its interest expense with its EBIT; that's encouraging. We should also note that Electric Utilities industry companies like Hokkaido Electric Power Company commonly do use debt without problems. Overall, it seems to us that Hokkaido Electric Power Company's balance sheet is really quite a risk to the business. For this reason we're pretty cautious about the stock, and we think shareholders should keep a close eye on its liquidity. 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. We've identified 4 warning signs with Hokkaido Electric Power Company (at least 2 which can't be ignored) , and understanding them should be part of your investment process.

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.