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.’ 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. We can see that FIPP S.A. (EPA:FIPP) does use debt in its business. But should shareholders be worried about its use of debt?
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, plenty of companies use debt to fund growth, without any negative consequences. The first step when considering a company’s debt levels is to consider its cash and debt together.
What Is FIPP’s Debt?
You can click the graphic below for the historical numbers, but it shows that as of June 2022 FIPP had €9.79m of debt, an increase on €8.30m, over one year. However, it does have €8.94m in cash offsetting this, leading to net debt of about €851.0k.
How Strong Is FIPP’s Balance Sheet?
We can see from the most recent balance sheet that FIPP had liabilities of €28.9m falling due within a year, and liabilities of €1.45m due beyond that. On the other hand, it had cash of €8.94m and €3.06m worth of receivables due within a year. So its liabilities total €18.4m more than the combination of its cash and short-term receivables.
When you consider that this deficiency exceeds the company’s €17.0m market capitalization, you might well be inclined to review the balance sheet intently. Hypothetically, extremely heavy dilution would be required if the company were forced to pay down its liabilities by raising capital at the current share price. There’s no doubt that we learn most about debt from the balance sheet. But it is FIPP’s earnings that will influence how the balance sheet holds up in the future. So when considering debt, it’s definitely worth looking at the earnings trend. Click here for an interactive snapshot.
Over 12 months, FIPP made a loss at the EBIT level, and saw its revenue drop to €2.0m, which is a fall of 9.4%. That’s not what we would hope to see.
Importantly, FIPP had an earnings before interest and tax (EBIT) loss over the last year. Indeed, it lost a very considerable €3.7m at the EBIT level. Considering that alongside the liabilities mentioned above make us nervous about the company. We’d want to see some strong near-term improvements before getting too interested in the stock. Not least because it had negative free cash flow of €912k over the last twelve months. That means it’s on the risky side of things. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. These risks can be hard to spot. Every company has them, and we’ve spotted 4 warning signs for FIPP (of which 2 can’t be ignored!) you should know about.
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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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.
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