Fountain (EBR:FOU) Has Debt But No Earnings; Should You Worry?

The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says '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 Fountain S.A. (EBR:FOU) does use debt in its business. But is this debt a concern to shareholders?

What Risk Does Debt Bring?

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. If things get really bad, the lenders can take control of the business. 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. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. 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 Fountain

What Is Fountain's Debt?

You can click the graphic below for the historical numbers, but it shows that as of December 2020 Fountain had €5.42m of debt, an increase on €4.09m, over one year. However, it does have €2.62m in cash offsetting this, leading to net debt of about €2.80m.

How Strong Is Fountain's Balance Sheet?

The latest balance sheet data shows that Fountain had liabilities of €8.47m due within a year, and liabilities of €5.07m falling due after that. Offsetting these obligations, it had cash of €2.62m as well as receivables valued at €2.03m due within 12 months. So it has liabilities totalling €8.89m more than its cash and near-term receivables, combined.

This deficit casts a shadow over the €4.08m company, like a colossus towering over mere mortals. So we definitely think shareholders need to watch this one closely. After all, Fountain would likely require a major re-capitalisation if it had to pay its creditors today. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since Fountain will need earnings to service that debt. So if you're keen to discover more about its earnings, it might be worth checking out this graph of its long term earnings trend.

In the last year Fountain had a loss before interest and tax, and actually shrunk its revenue by 26%, to €18m. That makes us nervous, to say the least.

Caveat Emptor

While Fountain's falling revenue is about as heartwarming as a wet blanket, arguably its earnings before interest and tax (EBIT) loss is even less appealing. Indeed, it lost a very considerable €1.1m at the EBIT level. Considering that alongside the liabilities mentioned above make us nervous about the company. It would need to improve its operations quickly for us to be interested in it. It's fair to say the loss of €713k didn't encourage us either; we'd like to see a profit. And until that time we think this is a risky stock. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. Be aware that Fountain is showing 2 warning signs in our investment analysis , and 1 of those makes us a bit uncomfortable...

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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