Is Fulham Shore (LON:FUL) Using Debt In A Risky Way?

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 seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. Importantly, The Fulham Shore PLC (LON:FUL) does carry debt. But the more important question is: how much risk is that debt creating?

What Risk Does Debt Bring?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. When we think about a company's use of debt, we first look at cash and debt together.

View our latest analysis for Fulham Shore

What Is Fulham Shore's Debt?

You can click the graphic below for the historical numbers, but it shows that as of September 2020 Fulham Shore had UK£18.3m of debt, an increase on UK£10.5m, over one year. On the flip side, it has UK£15.0m in cash leading to net debt of about UK£3.25m.

How Healthy Is Fulham Shore's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Fulham Shore had liabilities of UK£27.6m due within 12 months and liabilities of UK£81.1m due beyond that. Offsetting these obligations, it had cash of UK£15.0m as well as receivables valued at UK£5.54m due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by UK£88.1m.

This deficit casts a shadow over the UK£57.9m company, like a colossus towering over mere mortals. So we definitely think shareholders need to watch this one closely. After all, Fulham Shore 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 Fulham Shore will need earnings to service that debt. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

Over 12 months, Fulham Shore made a loss at the EBIT level, and saw its revenue drop to UK£52m, which is a fall of 22%. That makes us nervous, to say the least.

Caveat Emptor

While Fulham Shore's falling revenue is about as heartwarming as a wet blanket, arguably its earnings before interest and tax (EBIT) loss is even less appealing. To be specific the EBIT loss came in at UK£1.7m. When we look at that alongside the significant liabilities, we're not particularly confident about the company. We'd want to see some strong near-term improvements before getting too interested in the stock. It's fair to say the loss of UK£5.5m didn't encourage us either; we'd like to see a profit. In the meantime, we consider the stock to be risky. 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. Consider for instance, the ever-present spectre of investment risk. We've identified 3 warning signs with Fulham Shore (at least 1 which is significant) , and understanding them should be part of your investment process.

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

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