Does Fomento de Construcciones y Contratas (BME:FCC) Have A Healthy Balance Sheet?

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.' 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. We note that Fomento de Construcciones y Contratas, S.A. (BME:FCC) does have debt on its balance sheet. But is this debt a concern to shareholders?

What Risk Does Debt Bring?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. The first step when considering a company's debt levels is to consider its cash and debt together.

How Much Debt Does Fomento de Construcciones y Contratas Carry?

As you can see below, Fomento de Construcciones y Contratas had €5.06b of debt, at December 2024, which is about the same as the year before. You can click the chart for greater detail. On the flip side, it has €2.02b in cash leading to net debt of about €3.04b.

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

According to the last reported balance sheet, Fomento de Construcciones y Contratas had liabilities of €3.53b due within 12 months, and liabilities of €6.97b due beyond 12 months. Offsetting these obligations, it had cash of €2.02b as well as receivables valued at €3.12b due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by €5.36b.

When you consider that this deficiency exceeds the company's €4.88b market capitalization, you might well be inclined to review the balance sheet intently. In the scenario where the company had to clean up its balance sheet quickly, it seems likely shareholders would suffer extensive dilution.

See our latest analysis for Fomento de Construcciones y Contratas

We use two main ratios to inform us about debt levels relative to earnings. The first is net debt divided by earnings before interest, tax, depreciation, and amortization (EBITDA), while the second is how many times its earnings before interest and tax (EBIT) covers its interest expense (or its interest cover, for short). 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 2.4 times EBITDA, which isn't too much, but its interest cover looks a bit on the low side, with EBIT at only 4.9 times the interest expense. While that doesn't worry us too much, it does suggest the interest payments are somewhat of a burden. Notably Fomento de Construcciones y Contratas's EBIT was pretty flat over the last year. Ideally it can diminish its debt load by kick-starting earnings growth. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Fomento de Construcciones y Contratas can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. So the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. During the last three years, Fomento de Construcciones y Contratas produced sturdy free cash flow equating to 61% of its EBIT, about what we'd expect. This cold hard cash means it can reduce its debt when it wants to.

Our View

Fomento de Construcciones y Contratas's struggle to handle its total liabilities had us second guessing its balance sheet strength, but the other data-points we considered were relatively redeeming. But on the bright side, its ability to to convert EBIT to free cash flow isn't too shabby at all. Taking the abovementioned factors together we do think Fomento de Construcciones y Contratas's debt poses some risks to the business. So while that leverage does boost returns on equity, we wouldn't really want to see it increase from here. 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. To that end, you should be aware of the 2 warning signs we've spotted with Fomento de Construcciones y Contratas .

At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.

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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.