Is Niraku GC Holdings (HKG:1245) Using Debt In A Risky Way?

Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. As with many other companies Niraku GC Holdings, Inc. (HKG:1245) makes use of debt. But the more important question is: how much risk is that debt creating?

What Risk Does Debt Bring?

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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, debt can be an important tool in businesses, particularly capital heavy businesses. When we think about a company's use of debt, we first look at cash and debt together.

Check out our latest analysis for Niraku GC Holdings

What Is Niraku GC Holdings's Debt?

As you can see below, at the end of September 2020, Niraku GC Holdings had JP¥16.7b of debt, up from JP¥15.4b a year ago. Click the image for more detail. On the flip side, it has JP¥16.0b in cash leading to net debt of about JP¥643.0m.

How Healthy Is Niraku GC Holdings's Balance Sheet?

The latest balance sheet data shows that Niraku GC Holdings had liabilities of JP¥14.9b due within a year, and liabilities of JP¥42.7b falling due after that. On the other hand, it had cash of JP¥16.0b and JP¥92.0m worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by JP¥41.5b.

This deficit casts a shadow over the JP¥3.74b company, like a colossus towering over mere mortals. So we definitely think shareholders need to watch this one closely. At the end of the day, Niraku GC Holdings would probably need a major re-capitalization if its creditors were to demand repayment. The balance sheet is clearly the area to focus on when you are analysing debt. But it is Niraku GC Holdings's earnings that will influence how the balance sheet holds up in the future. 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.

Over 12 months, Niraku GC Holdings made a loss at the EBIT level, and saw its revenue drop to JP¥22b, which is a fall of 22%. To be frank that doesn't bode well.

Caveat Emptor

While Niraku GC Holdings's falling revenue is about as heartwarming as a wet blanket, arguably its earnings before interest and tax (EBIT) loss is even less appealing. Its EBIT loss was a whopping JP¥1.5b. When you combine this with the very significant balance sheet liabilities mentioned above, we are so wary of it that we are basically at a loss for the right words. Like every long-shot we're sure it has a glossy presentation outlining its blue-sky potential. But the reality is that it is low on liquid assets relative to liabilities, and it lost JP¥2.0b in the last year. So we think buying this stock is 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. Take risks, for example - Niraku GC Holdings has 3 warning signs (and 2 which are concerning) we think you should know about.

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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