Warren Buffett famously said, ‘Volatility is far from synonymous with risk.’ 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 note that FORTEC Elektronik AG (ETR:FEV) does have debt on its balance sheet. But is this debt a concern to shareholders?
Why Does Debt Bring Risk?
Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. If things get really bad, the lenders can take control of the business. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. When we examine debt levels, we first consider both cash and debt levels, together.
How Much Debt Does FORTEC Elektronik Carry?
As you can see below, at the end of December 2019, FORTEC Elektronik had €5.31m of debt, up from €4.40m a year ago. Click the image for more detail. However, it does have €8.60m in cash offsetting this, leading to net cash of €3.29m.
A Look At FORTEC Elektronik’s Liabilities
According to the last reported balance sheet, FORTEC Elektronik had liabilities of €9.74m due within 12 months, and liabilities of €10.7m due beyond 12 months. Offsetting this, it had €8.60m in cash and €8.55m in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by €3.30m.
Of course, FORTEC Elektronik has a market capitalization of €50.4m, so these liabilities are probably manageable. But there are sufficient liabilities that we would certainly recommend shareholders continue to monitor the balance sheet, going forward. While it does have liabilities worth noting, FORTEC Elektronik also has more cash than debt, so we’re pretty confident it can manage its debt safely.
It is just as well that FORTEC Elektronik’s load is not too heavy, because its EBIT was down 22% over the last year. When a company sees its earnings tank, it can sometimes find its relationships with its lenders turn sour. There’s no doubt that we learn most about debt from the balance sheet. But it is future earnings, more than anything, that will determine FORTEC Elektronik’s ability to maintain a healthy balance sheet going forward. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.
Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. FORTEC Elektronik 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, FORTEC Elektronik recorded free cash flow of 40% of its EBIT, which is weaker than we’d expect. That weak cash conversion makes it more difficult to handle indebtedness.
We could understand if investors are concerned about FORTEC Elektronik’s liabilities, but we can be reassured by the fact it has has net cash of €3.29m. So we don’t have any problem with FORTEC Elektronik’s use of debt. 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. Consider risks, for instance. Every company has them, and we’ve spotted 2 warning signs for FORTEC Elektronik you should know about.
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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