Faes Farma (BME:FAE) Seems To Use Debt Rather Sparingly

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. Importantly, Faes Farma, S.A. (BME:FAE) does carry debt. But should shareholders be worried about its use of debt?

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, debt can be an important tool in businesses, particularly capital heavy businesses. When we examine debt levels, we first consider both cash and debt levels, together.

Check out our latest analysis for Faes Farma

How Much Debt Does Faes Farma Carry?

You can click the graphic below for the historical numbers, but it shows that Faes Farma had €13.6m of debt in June 2020, down from €15.7m, one year before. But on the other hand it also has €87.9m in cash, leading to a €74.3m net cash position.

A Look At Faes Farma's Liabilities

We can see from the most recent balance sheet that Faes Farma had liabilities of €82.4m falling due within a year, and liabilities of €7.08m due beyond that. Offsetting this, it had €87.9m in cash and €103.9m in receivables that were due within 12 months. So it can boast €102.3m more liquid assets than total liabilities.

This short term liquidity is a sign that Faes Farma could probably pay off its debt with ease, as its balance sheet is far from stretched. Succinctly put, Faes Farma boasts net cash, so it's fair to say it does not have a heavy debt load!

Also positive, Faes Farma grew its EBIT by 27% in the last year, and that should make it easier to pay down debt, going forward. The balance sheet is clearly the area to focus on when you are analysing debt. 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. During the last three years, Faes Farma produced sturdy free cash flow equating to 66% of its EBIT, about what we'd expect. This cold hard cash means it can reduce its debt when it wants to.

Summing up

While it is always sensible to investigate a company's debt, in this case Faes Farma has €74.3m in net cash and a decent-looking balance sheet. And it impressed us with its EBIT growth of 27% over the last year. So is Faes Farma's debt a risk? It doesn't seem so to us. 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. Be aware that Faes Farma is showing 1 warning sign 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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