Here's Why FORTEC Elektronik (ETR:FEV) Can Manage Its Debt Responsibly

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.' 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, FORTEC Elektronik AG (ETR:FEV) does carry debt. But the real question is whether this debt is making the company risky.

When Is Debt A Problem?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. Of course, plenty of companies use debt to fund growth, without any negative consequences. When we examine debt levels, we first consider both cash and debt levels, together.

Check out our latest analysis for FORTEC Elektronik

How Much Debt Does FORTEC Elektronik Carry?

As you can see below, FORTEC Elektronik had €4.40m of debt at September 2020, down from €5.57m a year prior. However, its balance sheet shows it holds €9.13m in cash, so it actually has €4.73m net cash.

How Healthy Is FORTEC Elektronik's Balance Sheet?

We can see from the most recent balance sheet that FORTEC Elektronik had liabilities of €10.1m falling due within a year, and liabilities of €9.11m due beyond that. Offsetting this, it had €9.13m in cash and €10.4m in receivables that were due within 12 months. So its total liabilities are just about perfectly matched by its shorter-term, liquid assets.

This state of affairs indicates that FORTEC Elektronik's balance sheet looks quite solid, as its total liabilities are just about equal to its liquid assets. So while it's hard to imagine that the €56.9m company is struggling for cash, we still think it's worth monitoring its balance sheet. Simply put, the fact that FORTEC Elektronik has more cash than debt is arguably a good indication that it can manage its debt safely.

In fact FORTEC Elektronik's saving grace is its low debt levels, because its EBIT has tanked 26% in the last twelve months. When a company sees its earnings tank, it can sometimes find its relationships with its lenders turn sour. The balance sheet is clearly the area to focus on when you are analysing debt. 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'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 FORTEC Elektronik 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. In the last three years, FORTEC Elektronik's free cash flow amounted to 28% of its EBIT, less than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.

Summing up

While we empathize with investors who find debt concerning, you should keep in mind that FORTEC Elektronik has net cash of €4.73m, as well as more liquid assets than liabilities. So we are not troubled with FORTEC Elektronik's debt use. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. Be aware that FORTEC Elektronik is showing 2 warning signs in our investment analysis , 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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This article by Simply Wall St is general in nature. 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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