J. Front Retailing (TSE:3086) Has A Pretty 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.' 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 J. Front Retailing Co., Ltd. (TSE:3086) makes use of debt. But is this debt a concern to shareholders?

When Is Debt Dangerous?

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. 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. 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. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

See our latest analysis for J. Front Retailing

How Much Debt Does J. Front Retailing Carry?

The image below, which you can click on for greater detail, shows that J. Front Retailing had debt of JP¥193.5b at the end of August 2024, a reduction from JP¥239.3b over a year. However, it also had JP¥59.4b in cash, and so its net debt is JP¥134.1b.

How Healthy Is J. Front Retailing's Balance Sheet?

We can see from the most recent balance sheet that J. Front Retailing had liabilities of JP¥334.6b falling due within a year, and liabilities of JP¥361.6b due beyond that. Offsetting these obligations, it had cash of JP¥59.4b as well as receivables valued at JP¥144.7b due within 12 months. So its liabilities total JP¥492.0b more than the combination of its cash and short-term receivables.

This is a mountain of leverage relative to its market capitalization of JP¥500.5b. Should its lenders demand that it shore up the balance sheet, shareholders would likely face severe dilution.

We use two main ratios to inform us about debt levels relative to earnings. The first is net debt divided by earnings before interest, tax, depreciation, and amortization (EBITDA), while the second is how many times its earnings before interest and tax (EBIT) covers its interest expense (or its interest cover, for short). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

J. Front Retailing's net debt is only 1.2 times its EBITDA. And its EBIT easily covers its interest expense, being 24.9 times the size. So we're pretty relaxed about its super-conservative use of debt. In addition to that, we're happy to report that J. Front Retailing has boosted its EBIT by 98%, thus reducing the spectre of future debt repayments. There's no doubt that we learn most about debt from the balance sheet. But ultimately the future profitability of the business will decide if J. Front Retailing can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. So the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. Over the last three years, J. Front Retailing actually produced more free cash flow than EBIT. There's nothing better than incoming cash when it comes to staying in your lenders' good graces.

Our View

Happily, J. Front Retailing's impressive interest cover implies it has the upper hand on its debt. But the stark truth is that we are concerned by its level of total liabilities. When we consider the range of factors above, it looks like J. Front Retailing is pretty sensible with its use of debt. While that brings some risk, it can also enhance returns for shareholders. 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. These risks can be hard to spot. Every company has them, and we've spotted 2 warning signs for J. Front Retailing (of which 1 is significant!) you should know about.

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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This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.