Is Tohoku Electric Power Company (TSE:9506) Using Too Much Debt?

Simply Wall St · 10/17 21:09

David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the 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. Importantly, Tohoku Electric Power Company, Incorporated (TSE:9506) does carry debt. But should shareholders be worried about its use of debt?

When Is Debt A Problem?

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we examine debt levels, we first consider both cash and debt levels, together.

View our latest analysis for Tohoku Electric Power Company

What Is Tohoku Electric Power Company's Net Debt?

You can click the graphic below for the historical numbers, but it shows that Tohoku Electric Power Company had JP¥2.93t of debt in June 2024, down from JP¥3.35t, one year before. However, because it has a cash reserve of JP¥336.7b, its net debt is less, at about JP¥2.60t.

debt-equity-history-analysis
TSE:9506 Debt to Equity History October 17th 2024

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

Zooming in on the latest balance sheet data, we can see that Tohoku Electric Power Company had liabilities of JP¥1.05t due within 12 months and liabilities of JP¥3.25t due beyond that. Offsetting these obligations, it had cash of JP¥336.7b as well as receivables valued at JP¥247.8b due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by JP¥3.71t.

This deficit casts a shadow over the JP¥762.6b 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.

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

Strangely Tohoku Electric Power Company has a sky high EBITDA ratio of 5.0, implying high debt, but a strong interest coverage of 13.1. So either it has access to very cheap long term debt or that interest expense is going to grow! Notably, Tohoku Electric Power Company made a loss at the EBIT level, last year, but improved that to positive EBIT of JP¥299b 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 Tohoku 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.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. So it is important to check how much of its earnings before interest and tax (EBIT) converts to actual free cash flow. Looking at the most recent year, Tohoku Electric Power Company recorded free cash flow of 31% 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 Tohoku 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 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 Tohoku Electric Power Company commonly do use debt without problems. Overall, we think it's fair to say that Tohoku 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. 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 instance, we've identified 3 warning signs for Tohoku 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.