Here's Why Faes Farma (BME:FAE) Can Manage Its Debt Responsibly

Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk.' So it seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. Importantly, Faes Farma, S.A. (BME:FAE) does carry debt. But the real question is whether this debt is making the company risky.

When Is Debt Dangerous?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. 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 thing to do when considering how much debt a business uses is to look at its cash and debt together.

Check out our latest analysis for Faes Farma

What Is Faes Farma's Net Debt?

As you can see below, at the end of December 2022, Faes Farma had €30.9m of debt, up from €17.1m a year ago. Click the image for more detail. However, it does have €84.1m in cash offsetting this, leading to net cash of €53.2m.

How Strong Is Faes Farma's Balance Sheet?

We can see from the most recent balance sheet that Faes Farma had liabilities of €94.4m falling due within a year, and liabilities of €29.0m due beyond that. On the other hand, it had cash of €84.1m and €113.6m worth of receivables due within a year. So it can boast €74.3m 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.

The good news is that Faes Farma has increased its EBIT by 5.0% over twelve months, which should ease any concerns about debt repayment. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Faes Farma'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.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. 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's free cash flow amounted to 34% of its EBIT, less than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.

Summing Up

While it is always sensible to investigate a company's debt, in this case Faes Farma has €53.2m in net cash and a decent-looking balance sheet. On top of that, it increased its EBIT by 5.0% in the last twelve months. So we are not troubled with Faes Farma's debt use. 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. These risks can be hard to spot. Every company has them, and we've spotted 1 warning sign for Faes Farma you should know about.

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

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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.