Is Faes Farma (BME:FAE) A Risky Investment?

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.' 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 can see that Faes Farma, S.A. (BME:FAE) does use debt in its business. But is this debt a concern to shareholders?

What Risk Does Debt Bring?

Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. Of course, plenty of companies use debt to fund growth, without any negative consequences. 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 Debt?

As you can see below, Faes Farma had €7.14m of debt at June 2021, down from €13.6m a year prior. However, it does have €70.3m in cash offsetting this, leading to net cash of €63.2m.

How Healthy Is Faes Farma's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Faes Farma had liabilities of €71.0m due within 12 months and liabilities of €7.74m due beyond that. Offsetting these obligations, it had cash of €70.3m as well as receivables valued at €112.6m due within 12 months. So it actually has €104.2m 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. Succinctly put, Faes Farma boasts net cash, so it's fair to say it does not have a heavy debt load!

But the other side of the story is that Faes Farma saw its EBIT decline by 7.1% over the last year. If earnings continue to decline at that rate the company may have increasing difficulty managing its debt load. 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 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, while the tax-man may adore accounting profits, lenders only accept 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. Looking at the most recent three years, Faes Farma recorded free cash flow of 45% of its EBIT, which is weaker than we'd expect. That's not great, when it comes to paying down debt.

Summing up

While we empathize with investors who find debt concerning, you should keep in mind that Faes Farma has net cash of €63.2m, as well as more liquid assets than liabilities. So we are not troubled with Faes Farma's debt use. 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. Case in point: We've spotted 2 warning signs for Faes Farma you should be aware of.

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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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.
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