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

Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' 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. We note that Faes Farma, S.A. (BME:FAE) does have debt on its balance sheet. But is this debt a concern to shareholders?

When Is Debt Dangerous?

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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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. The first step when considering a company's debt levels is to consider its cash and debt together.

View our latest analysis for Faes Farma

What Is Faes Farma's Debt?

As you can see below, at the end of June 2022, Faes Farma had €8.52m of debt, up from €7.14m a year ago. Click the image for more detail. However, its balance sheet shows it holds €79.8m in cash, so it actually has €71.3m net cash.

How Healthy Is Faes Farma's Balance Sheet?

The latest balance sheet data shows that Faes Farma had liabilities of €70.6m due within a year, and liabilities of €25.8m falling due after that. Offsetting this, it had €79.8m in cash and €120.9m in receivables that were due within 12 months. So it actually has €104.4m 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. 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 21% in the last year, and that should make it easier to pay down debt, going forward. 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 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. Looking at the most recent three years, Faes Farma recorded free cash flow of 40% of its EBIT, which is weaker than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.

Summing Up

While we empathize with investors who find debt concerning, you should keep in mind that Faes Farma has net cash of €71.3m, as well as more liquid assets than liabilities. And it impressed us with its EBIT growth of 21% over the last year. So is Faes Farma's debt a risk? It doesn't seem so to us. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. Be aware that Faes Farma is showing 2 warning signs in our investment analysis , you should know about...

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.