Is FRONTEO (TSE:2158) A Risky Investment?

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.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. As with many other companies FRONTEO, Inc. (TSE:2158) makes use of debt. But the more important question is: how much risk is that debt creating?

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. 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, 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 FRONTEO

What Is FRONTEO's Debt?

You can click the graphic below for the historical numbers, but it shows that FRONTEO had JP¥2.81b of debt in December 2023, down from JP¥2.95b, one year before. However, because it has a cash reserve of JP¥1.57b, its net debt is less, at about JP¥1.24b.

How Healthy Is FRONTEO's Balance Sheet?

According to the last reported balance sheet, FRONTEO had liabilities of JP¥2.63b due within 12 months, and liabilities of JP¥1.17b due beyond 12 months. Offsetting these obligations, it had cash of JP¥1.57b as well as receivables valued at JP¥1.26b due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by JP¥971.0m.

Given FRONTEO has a market capitalization of JP¥26.2b, it's hard to believe these liabilities pose much threat. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time. There's no doubt that we learn most about debt from the balance sheet. But it is future earnings, more than anything, that will determine FRONTEO's ability to maintain a healthy balance sheet going forward. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

Over 12 months, FRONTEO made a loss at the EBIT level, and saw its revenue drop to JP¥6.7b, which is a fall of 18%. That's not what we would hope to see.

Caveat Emptor

While FRONTEO'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¥1.4b 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. However, it doesn't help that it burned through JP¥240m of cash over the last year. So suffice it to say we do consider the stock to be risky. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. For instance, we've identified 1 warning sign for FRONTEO that you should be aware of.

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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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.