Does NF Holdings (TYO:6864) Have A Healthy Balance Sheet?

David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the permanent loss of capital.' 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. We note that NF Holdings Corporation (TYO:6864) does have debt on its balance sheet. 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 NF Holdings

How Much Debt Does NF Holdings Carry?

You can click the graphic below for the historical numbers, but it shows that as of September 2020 NF Holdings had JP¥2.28b of debt, an increase on JP¥2.10b, over one year. However, its balance sheet shows it holds JP¥6.91b in cash, so it actually has JP¥4.63b net cash.

A Look At NF Holdings's Liabilities

The latest balance sheet data shows that NF Holdings had liabilities of JP¥2.81b due within a year, and liabilities of JP¥2.31b falling due after that. Offsetting these obligations, it had cash of JP¥6.91b as well as receivables valued at JP¥2.51b due within 12 months. So it can boast JP¥4.30b more liquid assets than total liabilities.

This luscious liquidity implies that NF Holdings's balance sheet is sturdy like a giant sequoia tree. With this in mind one could posit that its balance sheet is as strong as beautiful a rare rhino. Succinctly put, NF Holdings boasts net cash, so it's fair to say it does not have a heavy debt load!

But the bad news is that NF Holdings has seen its EBIT plunge 19% in the last twelve months. We think hat kind of performance, if repeated frequently, could well lead to difficulties for the stock. There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since NF Holdings 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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. While NF Holdings 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. Over the most recent three years, NF Holdings recorded free cash flow worth 53% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This cold hard cash means it can reduce its debt when it wants to.

Summing up

While we empathize with investors who find debt concerning, you should keep in mind that NF Holdings has net cash of JP¥4.63b, as well as more liquid assets than liabilities. So we are not troubled with NF Holdings'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. Be aware that NF Holdings is showing 2 warning signs in our investment analysis , and 1 of those is concerning...

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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