We believe ForFarmers (AMS: FFARM) can stay on top of its debt
Howard Marks put it well when he said that, rather than worrying about stock price volatility, “the possibility of permanent loss is the risk I worry about … and every investor practice that I know is worried. So it seems like smart money knows that debt – which is usually involved in bankruptcies – is a very important factor, when you assess the risk level of a business. We can see that ForFarmers NV (AMS: FFARM) uses debt in its business. But does this debt worry shareholders?
What risk does debt entail?
Debts and other liabilities become risky for a business when it cannot easily meet these obligations, either with free cash flow or by raising capital at an attractive price. Ultimately, if the company cannot meet its legal debt repayment obligations, shareholders could walk away with nothing. However, a more common (but still costly) event is when a company has to issue stock at bargain prices, constantly diluting shareholders, just to strengthen its balance sheet. That said, the most common situation is where a business manages its debt reasonably well – and to its own advantage. The first step in examining a company’s debt levels is to consider its cash flow and debt together.
See our latest review for ForFarmers
How much debt does ForFarmers have?
The image below, which you can click for more details, shows ForFarmers owed â¬ 88.3 million in debt at the end of June 2021, a reduction of â¬ 102.3 million over one year. However, he also had 45.9 million euros in cash, so his net debt is 42.4 million euros.
How healthy is ForFarmers’ track record?
The most recent balance sheet shows that ForFarmers had liabilities of 355.5 million euros due within one year and liabilities of 157.8 million euros due beyond. In return, it had â¬ 45.9 million in cash and â¬ 262.3 million in receivables due within 12 months. It therefore has total liabilities of â¬ 205.2 million more than its combined cash and short-term receivables.
This is a mountain of leverage compared to its market capitalization of â¬ 329.1 million. If its lenders asked it to consolidate the balance sheet, shareholders would likely face severe dilution.
We use two main ratios to inform us about the levels of debt compared to earnings. The first is net debt divided by earnings before interest, taxes, depreciation, and amortization (EBITDA), while the second is the number of times its profit before interest and taxes (EBIT) covers its interest expense (or its coverage of interest, for short). The advantage of this approach is that we take into account both the absolute amount of debt (with net debt versus EBITDA) and the actual interest charges associated with this debt (with its coverage rate). interests).
ForFarmers’ net debt is only 0.59 times its EBITDA. And its EBIT easily covers its interest costs, being 35.7 times higher. We could therefore say that he is no more threatened by his debt than an elephant is by a mouse. In fact, ForFarmers’ saving grace is its low level of debt, as its EBIT has fallen 32% in the past twelve months. Falling profits (if the trend continues) could eventually make even small debt risky enough. When analyzing debt levels, the balance sheet is the obvious starting point. But it is future profits, more than anything, that will determine ForFarmers’ ability to maintain a healthy balance sheet going forward. So, if you want to see what the professionals think, you might find this free analyst earnings forecast report interesting.
Finally, a business needs free cash flow to pay off debts; accounting profits are not enough. The logical step is therefore to examine the proportion of this EBIT that corresponds to the actual free cash flow. Over the past three years, ForFarmers has recorded free cash flow totaling 92% of its EBIT, which is higher than what we usually expected. This positions it well to repay debt if it is desirable.
Our point of view
From what we’ve seen, ForFarmers doesn’t find it easy, given its rate of EBIT growth, but the other factors we’ve taken into account make us optimistic. There is no doubt that his ability to cover his interest costs with his EBIT is pretty flash. Looking at all of this data, we feel a little cautious about ForFarmers’ debt levels. While we understand that debt can improve returns on equity, we suggest shareholders watch their debt level closely, lest they increase. There is no doubt that we learn the most about debt from the balance sheet. But at the end of the day, every business can contain risks that exist off the balance sheet. Concrete example: we have spotted 4 warning signs for ForFarmers you must be aware.
At the end of the day, it’s often best to focus on businesses that don’t have net debt. You can access our special list of these companies (all with a history of profit growth). It’s free.
Do you have any feedback on this item? Are you worried about the content? Get in touch with us directly. You can also send an email to the editorial team (at) simplywallst.com.
This Simply Wall St article is general in nature. We provide commentary based on historical data and analyst forecasts using only unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell shares and does not take into account your goals or your financial situation. Our aim is to bring you long-term, targeted analysis based on fundamental data. Note that our analysis may not take into account the latest announcements from price sensitive companies or qualitative documents. Simply Wall St has no position in any of the stocks mentioned.