fonfun (TYO:2323) Has A Pretty Healthy Balance Sheet

Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' 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. Importantly, fonfun corporation (TYO:2323) does carry debt. But the real question is whether this debt is making the company risky.

When Is Debt Dangerous?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. If things get really bad, the lenders can take control of the business. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. 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.

View our latest analysis for fonfun

What Is fonfun's Debt?

As you can see below, at the end of September 2020, fonfun had JP¥304.0m of debt, up from JP¥286.0m a year ago. Click the image for more detail. However, it does have JP¥570.0m in cash offsetting this, leading to net cash of JP¥266.0m.

How Healthy Is fonfun's Balance Sheet?

The latest balance sheet data shows that fonfun had liabilities of JP¥209.0m due within a year, and liabilities of JP¥198.0m falling due after that. Offsetting these obligations, it had cash of JP¥570.0m as well as receivables valued at JP¥104.0m due within 12 months. So it actually has JP¥267.0m more liquid assets than total liabilities.

This surplus suggests that fonfun has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Simply put, the fact that fonfun has more cash than debt is arguably a good indication that it can manage its debt safely.

It is well worth noting that fonfun's EBIT shot up like bamboo after rain, gaining 86% in the last twelve months. That'll make it easier to manage its debt. The balance sheet is clearly the area to focus on when you are analysing debt. But it is fonfun'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.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. While fonfun has net cash on its balance sheet, it's still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. During the last two years, fonfun burned a lot of cash. While investors are no doubt expecting a reversal of that situation in due course, it clearly does mean its use of debt is more risky.

Summing up

While it is always sensible to investigate a company's debt, in this case fonfun has JP¥266.0m in net cash and a decent-looking balance sheet. And it impressed us with its EBIT growth of 86% over the last year. So we are not troubled with fonfun's debt use. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. Take risks, for example - fonfun has 3 warning signs (and 1 which is a bit unpleasant) we think 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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