We Think FLSmidth (CPH:FLS) Can Manage Its Debt With Ease

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.' 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. As with many other companies FLSmidth & Co. A/S (CPH:FLS) makes use of debt. 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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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.

Check out our latest analysis for FLSmidth

What Is FLSmidth's Debt?

The image below, which you can click on for greater detail, shows that FLSmidth had debt of kr.761.0m at the end of March 2022, a reduction from kr.2.53b over a year. However, it does have kr.1.95b in cash offsetting this, leading to net cash of kr.1.19b.

A Look At FLSmidth's Liabilities

Zooming in on the latest balance sheet data, we can see that FLSmidth had liabilities of kr.10.6b due within 12 months and liabilities of kr.2.64b due beyond that. Offsetting these obligations, it had cash of kr.1.95b as well as receivables valued at kr.7.91b due within 12 months. So its liabilities total kr.3.33b more than the combination of its cash and short-term receivables.

While this might seem like a lot, it is not so bad since FLSmidth has a market capitalization of kr.11.1b, and so it could probably strengthen its balance sheet by raising capital if it needed to. However, it is still worthwhile taking a close look at its ability to pay off debt. Despite its noteworthy liabilities, FLSmidth boasts net cash, so it's fair to say it does not have a heavy debt load!

Better yet, FLSmidth grew its EBIT by 133% last year, which is an impressive improvement. If maintained that growth will make the debt even more manageable in the years ahead. 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 FLSmidth'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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. FLSmidth 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. Over the last three years, FLSmidth recorded free cash flow worth a fulsome 97% of its EBIT, which is stronger than we'd usually expect. That puts it in a very strong position to pay down debt.

Summing up

While FLSmidth does have more liabilities than liquid assets, it also has net cash of kr.1.19b. The cherry on top was that in converted 97% of that EBIT to free cash flow, bringing in kr.799m. So we don't think FLSmidth's use of debt is risky. 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. These risks can be hard to spot. Every company has them, and we've spotted 2 warning signs for FLSmidth 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.