Does FTGroup (TYO:2763) Have A Healthy Balance Sheet?

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. We note that FTGroup Co., Ltd. (TYO:2763) does have debt on its balance sheet. But is this debt a concern to shareholders?

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. If things get really bad, the lenders can take control of the business. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. Of course, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest 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 FTGroup

How Much Debt Does FTGroup Carry?

You can click the graphic below for the historical numbers, but it shows that FTGroup had JP¥8.00b of debt in December 2020, down from JP¥10.7b, one year before. But on the other hand it also has JP¥10.7b in cash, leading to a JP¥2.68b net cash position.

How Healthy Is FTGroup's Balance Sheet?

According to the last reported balance sheet, FTGroup had liabilities of JP¥10.4b due within 12 months, and liabilities of JP¥6.60b due beyond 12 months. On the other hand, it had cash of JP¥10.7b and JP¥8.02b worth of receivables due within a year. So it can boast JP¥1.65b more liquid assets than total liabilities.

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

On the other hand, FTGroup's EBIT dived 11%, over the last year. We think hat kind of performance, if repeated frequently, could well lead to difficulties for the stock. The balance sheet is clearly the area to focus on when you are analysing debt. But it is FTGroup's earnings that will influence how the balance sheet holds up in the future. 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.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. FTGroup may have net cash on the balance sheet, but it is still interesting to look at how well the business converts its earnings before interest and tax (EBIT) to free cash flow, because that will influence both its need for, and its capacity to manage debt. Looking at the most recent three years, FTGroup recorded free cash flow of 30% of its EBIT, which is weaker than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.

Summing up

While it is always sensible to investigate a company's debt, in this case FTGroup has JP¥2.68b in net cash and a decent-looking balance sheet. So we are not troubled with FTGroup's debt use. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. For example - FTGroup has 1 warning sign we think you should be aware of.

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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