Does Faes Farma (BME:FAE) 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.' So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. As with many other companies Faes Farma, S.A. (BME:FAE) makes use of debt. But the real question is whether this debt is making the company risky.

When Is Debt A Problem?

Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we think about a company's use of debt, we first look at cash and debt together.

See our latest analysis for Faes Farma

What Is Faes Farma's Net Debt?

As you can see below, Faes Farma had €8.64m of debt, at June 2023, which is about the same as the year before. You can click the chart for greater detail. But it also has €46.5m in cash to offset that, meaning it has €37.9m net cash.

How Healthy Is Faes Farma's Balance Sheet?

We can see from the most recent balance sheet that Faes Farma had liabilities of €81.6m falling due within a year, and liabilities of €29.1m due beyond that. Offsetting these obligations, it had cash of €46.5m as well as receivables valued at €120.6m due within 12 months. So it actually has €56.4m more liquid assets than total liabilities.

This surplus suggests that Faes Farma has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Simply put, the fact that Faes Farma has more cash than debt is arguably a good indication that it can manage its debt safely.

While Faes Farma doesn't seem to have gained much on the EBIT line, at least earnings remain stable for now. There's no doubt that we learn most about debt from the balance sheet. But ultimately the future profitability of the business will decide if Faes Farma 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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. Faes Farma 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. In the last three years, Faes Farma created free cash flow amounting to 17% of its EBIT, an uninspiring performance. For us, cash conversion that low sparks a little paranoia about is ability to extinguish debt.

Summing Up

While we empathize with investors who find debt concerning, you should keep in mind that Faes Farma has net cash of €37.9m, as well as more liquid assets than liabilities. So we don't have any problem with Faes Farma's use of debt. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. For instance, we've identified 3 warning signs for Faes Farma (1 doesn't sit too well with us) you should be aware of.

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.