Is CrossforLtd (TYO:7810) Using Too Much Debt?

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.' 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. As with many other companies Crossfor Co.,Ltd. (TYO:7810) makes use of debt. But is this debt a concern to shareholders?

When Is Debt A Problem?

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. 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, plenty of companies use debt to fund growth, without any negative consequences. 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 CrossforLtd

What Is CrossforLtd's Debt?

You can click the graphic below for the historical numbers, but it shows that as of July 2020 CrossforLtd had JP¥3.13b of debt, an increase on JP¥2.51b, over one year. However, because it has a cash reserve of JP¥1.35b, its net debt is less, at about JP¥1.78b.

How Healthy Is CrossforLtd's Balance Sheet?

We can see from the most recent balance sheet that CrossforLtd had liabilities of JP¥1.58b falling due within a year, and liabilities of JP¥1.65b due beyond that. On the other hand, it had cash of JP¥1.35b and JP¥208.0m worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by JP¥1.67b.

While this might seem like a lot, it is not so bad since CrossforLtd has a market capitalization of JP¥4.74b, and so it could probably strengthen its balance sheet by raising capital if it needed to. But it's clear that we should definitely closely examine whether it can manage its debt without dilution. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since CrossforLtd 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 CrossforLtd had a loss before interest and tax, and actually shrunk its revenue by 33%, to JP¥2.3b. To be frank that doesn't bode well.

Caveat Emptor

While CrossforLtd'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 JP¥414m at the EBIT level. When we look at that and recall the liabilities on its balance sheet, relative to cash, it seems unwise to us for the company to have any debt. Quite frankly we think the balance sheet is far from match-fit, although it could be improved with time. For example, we would not want to see a repeat of last year's loss of JP¥611m. So we do think this stock is quite risky. 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. Like risks, for instance. Every company has them, and we've spotted 3 warning signs for CrossforLtd (of which 2 don't sit too well with us!) you should know about.

If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.

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