Is Hokkaido Electric Power Company (TSE:9509) A Risky Investment?

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 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. Importantly, Hokkaido Electric Power Company, Incorporated (TSE:9509) does carry debt. 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. If things get really bad, the lenders can take control of the business. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

View our latest analysis for Hokkaido Electric Power Company

What Is Hokkaido Electric Power Company's Net Debt?

As you can see below, Hokkaido Electric Power Company had JP¥1.40t of debt at June 2024, down from JP¥1.50t a year prior. However, because it has a cash reserve of JP¥99.9b, its net debt is less, at about JP¥1.30t.

A Look At Hokkaido Electric Power Company's Liabilities

According to the last reported balance sheet, Hokkaido Electric Power Company had liabilities of JP¥400.9b due within 12 months, and liabilities of JP¥1.35t due beyond 12 months. Offsetting this, it had JP¥99.9b in cash and JP¥89.7b in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by JP¥1.56t.

The deficiency here weighs heavily on the JP¥216.7b 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'd watch its balance sheet closely, without a doubt. After all, Hokkaido Electric Power Company 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). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

Hokkaido Electric Power Company's net debt to EBITDA ratio is 8.2 which suggests rather high debt levels, but its interest cover of 7.6 times suggests the debt is easily serviced. Our best guess is that the company does indeed have significant debt obligations. Pleasingly, Hokkaido Electric Power Company is growing its EBIT faster than former Australian PM Bob Hawke downs a yard glass, boasting a 503% gain in the last twelve months. There's no doubt that we learn most about debt from the balance sheet. 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'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 we clearly need to look at whether that EBIT is leading to corresponding free cash flow. In the last three years, Hokkaido Electric Power Company created free cash flow amounting to 3.8% of its EBIT, an uninspiring performance. That limp level of cash conversion undermines its ability to manage and pay 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 growing 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, we think it's fair to say that Hokkaido Electric Power Company has enough debt that there are some real risks around the balance sheet. If all goes well, that should boost returns, but on the flip side, the risk of permanent capital loss is elevated by the debt. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. For instance, we've identified 3 warning signs for Hokkaido Electric Power Company (2 can't be ignored) you should be aware of.

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.