Stock Analysis

We Think Falabella (SNSE:FALABELLA) Can Stay On Top Of Its Debt

SNSE:FALABELLA
Source: Shutterstock

Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk.' 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. Importantly, Falabella S.A. (SNSE:FALABELLA) does carry debt. But is this debt a concern to shareholders?

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What Risk Does Debt Bring?

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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. The first step when considering a company's debt levels is to consider its cash and debt together.

See our latest analysis for Falabella

What Is Falabella's Net Debt?

The image below, which you can click on for greater detail, shows that Falabella had debt of CL$4.54t at the end of September 2021, a reduction from CL$5.03t over a year. However, it also had CL$588.3b in cash, and so its net debt is CL$3.95t.

debt-equity-history-analysis
SNSE:FALABELLA Debt to Equity History February 1st 2022

How Strong Is Falabella's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Falabella had liabilities of CL$3.59t due within 12 months and liabilities of CL$9.70t due beyond that. Offsetting these obligations, it had cash of CL$588.3b as well as receivables valued at CL$453.7b due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by CL$12t.

This deficit casts a shadow over the CL$7.14t company, like a colossus towering over mere mortals. So we'd watch its balance sheet closely, without a doubt. After all, Falabella would likely require a major re-capitalisation if it had to pay its creditors today.

We measure a company's debt load relative to its earnings power by looking at its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and by calculating how easily its earnings before interest and tax (EBIT) cover its interest expense (interest cover). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

With net debt to EBITDA of 3.0 Falabella has a fairly noticeable amount of debt. On the plus side, its EBIT was 9.6 times its interest expense, and its net debt to EBITDA, was quite high, at 3.0. Pleasingly, Falabella is growing its EBIT faster than former Australian PM Bob Hawke downs a yard glass, boasting a 460% gain in the last twelve months. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately the future profitability of the business will decide if Falabella can strengthen its balance sheet over time. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. So it's worth checking how much of that EBIT is backed by free cash flow. Happily for any shareholders, Falabella actually produced more free cash flow than EBIT over the last three years. There's nothing better than incoming cash when it comes to staying in your lenders' good graces.

Our View

Falabella's level of total liabilities was a real negative on this analysis, although the other factors we considered were considerably better. There's no doubt that its ability to to convert EBIT to free cash flow is pretty flash. When we consider all the factors mentioned above, we do feel a bit cautious about Falabella's use of debt. While we appreciate debt can enhance returns on equity, we'd suggest that shareholders keep close watch on its debt levels, lest they increase. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. For example - Falabella has 1 warning sign we think you should be aware of.

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

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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.

About SNSE:FALABELLA

Falabella

Engages in the retail sale of clothing, accessories, home products, electronics, and beauty and other products in Chile, Peru, Colombia, Brazil, Mexico, Uruguay, and Argentina.

Proven track record with adequate balance sheet.

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