Health Check: How Prudently Does Future Retail (NSE:FRETAIL) Use Debt?

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.' 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. We note that Future Retail Limited (NSE:FRETAIL) does have debt on its balance sheet. But should shareholders be worried about its use of debt?

Why Does Debt Bring Risk?

Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. If things get really bad, the lenders can take control of the business. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. 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.

See our latest analysis for Future Retail

What Is Future Retail's Net Debt?

The image below, which you can click on for greater detail, shows that at March 2021 Future Retail had debt of ₹118.9b, up from ₹88.9b in one year. And it doesn't have much cash, so its net debt is about the same.

How Strong Is Future Retail's Balance Sheet?

We can see from the most recent balance sheet that Future Retail had liabilities of ₹124.6b falling due within a year, and liabilities of ₹54.8b due beyond that. Offsetting this, it had ₹1.35b in cash and ₹4.10b in receivables that were due within 12 months. So it has liabilities totalling ₹173.9b more than its cash and near-term receivables, combined.

The deficiency here weighs heavily on the ₹28.5b 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 definitely think shareholders need to watch this one closely. At the end of the day, Future Retail would probably need a major re-capitalization if its creditors were to demand repayment. There's no doubt that we learn most about debt from the balance sheet. But it is Future Retail's earnings that will influence how the balance sheet holds up in the future. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

In the last year Future Retail had a loss before interest and tax, and actually shrunk its revenue by 69%, to ₹64b. To be frank that doesn't bode well.

Caveat Emptor

While Future Retail'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 ₹19b at the EBIT level. 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 burned through ₹1.9b in the last year. So we consider this a high risk stock, and we're worried its share price could sink faster than than a dingy with a great white shark attacking it. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. Be aware that Future Retail is showing 2 warning signs in our investment analysis , and 1 of those shouldn't be ignored...

At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.

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