Is Fomento de Construcciones y Contratas (BME:FCC) A Risky Investment?

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.' 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, Fomento de Construcciones y Contratas, S.A. (BME:FCC) does carry debt. But the more important question is: how much risk is that debt creating?

When Is Debt A Problem?

Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. Of course, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. The first step when considering a company's debt levels is to consider its cash and debt together.

View our latest analysis for Fomento de Construcciones y Contratas

What Is Fomento de Construcciones y Contratas's Net Debt?

You can click the graphic below for the historical numbers, but it shows that Fomento de Construcciones y Contratas had €4.59b of debt in June 2024, down from €4.99b, one year before. However, it also had €1.74b in cash, and so its net debt is €2.85b.

How Healthy Is Fomento de Construcciones y Contratas' Balance Sheet?

According to the last reported balance sheet, Fomento de Construcciones y Contratas had liabilities of €5.22b due within 12 months, and liabilities of €6.37b due beyond 12 months. Offsetting these obligations, it had cash of €1.74b as well as receivables valued at €3.03b due within 12 months. So it has liabilities totalling €6.82b more than its cash and near-term receivables, combined.

When you consider that this deficiency exceeds the company's €5.54b market capitalization, you might well be inclined to review the balance sheet intently. Hypothetically, extremely heavy dilution would be required if the company were forced to pay down its liabilities by raising capital at the current share price.

In order to size up a company's debt relative to its earnings, we calculate its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and its earnings before interest and tax (EBIT) divided by its interest expense (its interest cover). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

Fomento de Construcciones y Contratas has net debt worth 1.9 times EBITDA, which isn't too much, but its interest cover looks a bit on the low side, with EBIT at only 6.4 times the interest expense. While these numbers do not alarm us, it's worth noting that the cost of the company's debt is having a real impact. Also relevant is that Fomento de Construcciones y Contratas has grown its EBIT by a very respectable 26% in the last year, thus enhancing its ability to pay down debt. 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 Fomento de Construcciones y Contratas'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. So we always check how much of that EBIT is translated into free cash flow. Over the most recent three years, Fomento de Construcciones y Contratas recorded free cash flow worth 52% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This free cash flow puts the company in a good position to pay down debt, when appropriate.

Our View

Neither Fomento de Construcciones y Contratas's ability to handle its total liabilities nor its net debt to EBITDA gave us confidence in its ability to take on more debt. But its EBIT growth rate tells a very different story, and suggests some resilience. We think that Fomento de Construcciones y Contratas's debt does make it a bit risky, after considering the aforementioned data points together. Not all risk is bad, as it can boost share price returns if it pays off, but this debt risk is worth keeping in mind. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. Be aware that Fomento de Construcciones y Contratas is showing 4 warning signs in our investment analysis , and 1 of those is a bit concerning...

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.