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. It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. Importantly, F.G. Europe S.A. (ATH:FGE) does carry debt. But is this debt a concern to shareholders?
What Risk Does Debt Bring?
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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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, 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.
What Is F.G. Europe's Debt?
The image below, which you can click on for greater detail, shows that F.G. Europe had debt of €56.5m at the end of June 2019, a reduction from €76.4m over a year. However, it does have €57.3m in cash offsetting this, leading to net cash of €790.0k.
A Look At F.G. Europe's Liabilities
According to the last reported balance sheet, F.G. Europe had liabilities of €77.8m due within 12 months, and liabilities of €44.4m due beyond 12 months. Offsetting these obligations, it had cash of €57.3m as well as receivables valued at €42.9m due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by €22.0m.
This is a mountain of leverage relative to its market capitalization of €26.0m. This suggests shareholders would heavily diluted if the company needed to shore up its balance sheet in a hurry. While it does have liabilities worth noting, F.G. Europe also has more cash than debt, so we're pretty confident it can manage its debt safely.
Pleasingly, F.G. Europe is growing its EBIT faster than former Australian PM Bob Hawke downs a yard glass, boasting a 165% gain in the last twelve months. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since F.G. Europe will need earnings to service that debt. 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 F.G. Europe 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. Looking at the most recent three years, F.G. Europe recorded free cash flow of 25% of its EBIT, which is weaker than we'd expect. That's not great, when it comes to paying down debt.
Although F.G. Europe's balance sheet isn't particularly strong, due to the total liabilities, it is clearly positive to see that it has net cash of €790.0k. And it impressed us with its EBIT growth of 165% over the last year. So while F.G. Europe does not have a great balance sheet, it's certainly not too bad. While F.G. Europe didn't make a statutory profit in the last year, its positive EBIT suggests that profitability might not be far away.Click here to see if its earnings are heading in the right direction, over the medium term.
At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.
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