Does Festaria Holdings (TYO:2736) Have A Healthy Balance Sheet?

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 Festaria Holdings Co., Ltd. (TYO:2736) makes use of debt. But the real question is whether this debt is making the company risky.

When Is Debt Dangerous?

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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. 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.

Check out our latest analysis for Festaria Holdings

What Is Festaria Holdings's Net Debt?

As you can see below, at the end of November 2020, Festaria Holdings had JP¥5.21b of debt, up from JP¥5.01b a year ago. Click the image for more detail. However, it does have JP¥1.47b in cash offsetting this, leading to net debt of about JP¥3.74b.

A Look At Festaria Holdings' Liabilities

We can see from the most recent balance sheet that Festaria Holdings had liabilities of JP¥4.57b falling due within a year, and liabilities of JP¥3.10b due beyond that. Offsetting this, it had JP¥1.47b in cash and JP¥863.0m in receivables that were due within 12 months. So it has liabilities totalling JP¥5.34b more than its cash and near-term receivables, combined.

The deficiency here weighs heavily on the JP¥1.43b 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'd watch its balance sheet closely, without a doubt. At the end of the day, Festaria Holdings 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 Festaria Holdings'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.

Over 12 months, Festaria Holdings made a loss at the EBIT level, and saw its revenue drop to JP¥8.3b, which is a fall of 19%. That's not what we would hope to see.

Caveat Emptor

Not only did Festaria Holdings's revenue slip over the last twelve months, but it also produced negative earnings before interest and tax (EBIT). To be specific the EBIT loss came in at JP¥111m. Combining this information with the significant liabilities we already touched on makes us very hesitant about this stock, to say the least. Of course, it may be able to improve its situation with a bit of luck and good execution. But we think that is unlikely, given it is low on liquid assets, and burned through JP¥186m in the last year. So we consider this a high risk stock and we wouldn't be at all surprised if the company asks shareholders for money before long. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. For example, we've discovered 3 warning signs for Festaria Holdings (1 doesn't sit too well with us!) that you should be aware of before investing here.

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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