Francotyp-Postalia Holding (ETR:FPH) Takes On Some Risk With Its Use Of Debt

David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the permanent loss of capital.' So it seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. Importantly, Francotyp-Postalia Holding AG (ETR:FPH) does carry debt. But the real question is whether this debt is making the company risky.

Why Does Debt Bring Risk?

Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

Our analysis indicates that FPH is potentially undervalued!

What Is Francotyp-Postalia Holding's Debt?

As you can see below, at the end of June 2022, Francotyp-Postalia Holding had €31.6m of debt, up from €29.6m a year ago. Click the image for more detail. But on the other hand it also has €38.2m in cash, leading to a €6.61m net cash position.

How Strong Is Francotyp-Postalia Holding's Balance Sheet?

The latest balance sheet data shows that Francotyp-Postalia Holding had liabilities of €102.5m due within a year, and liabilities of €62.6m falling due after that. On the other hand, it had cash of €38.2m and €36.2m worth of receivables due within a year. So its liabilities total €90.7m more than the combination of its cash and short-term receivables.

This deficit casts a shadow over the €52.5m company, like a colossus towering over mere mortals. So we'd watch its balance sheet closely, without a doubt. At the end of the day, Francotyp-Postalia Holding would probably need a major re-capitalization if its creditors were to demand repayment. Given that Francotyp-Postalia Holding has more cash than debt, we're pretty confident it can handle its debt, despite the fact that it has a lot of liabilities in total.

It was also good to see that despite losing money on the EBIT line last year, Francotyp-Postalia Holding turned things around in the last 12 months, delivering and EBIT of €18m. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Francotyp-Postalia Holding 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 business needs free cash flow to pay off debt; accounting profits just don't cut it. While Francotyp-Postalia Holding 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. Over the most recent year, Francotyp-Postalia Holding recorded free cash flow worth 78% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This cold hard cash means it can reduce its debt when it wants to.

Summing Up

Although Francotyp-Postalia Holding's balance sheet isn't particularly strong, due to the total liabilities, it is clearly positive to see that it has net cash of €6.61m. And it impressed us with free cash flow of €14m, being 78% of its EBIT. So although we see some areas for improvement, we're not too worried about Francotyp-Postalia Holding's balance sheet. 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. Be aware that Francotyp-Postalia Holding is showing 2 warning signs in our investment analysis , you should know about...

If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.

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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.