Here's Why Focus Home Interactive Société anonyme (EPA:ALFOC) Can Manage Its Debt Responsibly

The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. We note that Focus Home Interactive Société anonyme (EPA:ALFOC) does have debt on its balance sheet. But the more important question is: how much risk is that debt creating?

Why Does Debt Bring Risk?

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 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, 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 Focus Home Interactive Société anonyme

What Is Focus Home Interactive Société anonyme's Net Debt?

You can click the graphic below for the historical numbers, but it shows that as of September 2020 Focus Home Interactive Société anonyme had €14.7m of debt, an increase on €822.0k, over one year. However, it does have €28.7m in cash offsetting this, leading to net cash of €14.0m.

A Look At Focus Home Interactive Société anonyme's Liabilities

According to the last reported balance sheet, Focus Home Interactive Société anonyme had liabilities of €37.4m due within 12 months, and liabilities of €15.2m due beyond 12 months. Offsetting these obligations, it had cash of €28.7m as well as receivables valued at €22.4m due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by €1.46m.

Having regard to Focus Home Interactive Société anonyme's size, it seems that its liquid assets are well balanced with its total liabilities. So while it's hard to imagine that the €348.6m company is struggling for cash, we still think it's worth monitoring its balance sheet. While it does have liabilities worth noting, Focus Home Interactive Société anonyme also has more cash than debt, so we're pretty confident it can manage its debt safely.

And we also note warmly that Focus Home Interactive Société anonyme grew its EBIT by 17% last year, making its debt load easier to handle. 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 Focus Home Interactive Société anonyme 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 company can only pay off debt with cold hard cash, not accounting profits. While Focus Home Interactive Société anonyme has net cash on its balance sheet, it's still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. Looking at the most recent three years, Focus Home Interactive Société anonyme recorded free cash flow of 29% of its EBIT, which is weaker than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.

Summing up

We could understand if investors are concerned about Focus Home Interactive Société anonyme's liabilities, but we can be reassured by the fact it has has net cash of €14.0m. And it impressed us with its EBIT growth of 17% over the last year. So we don't have any problem with Focus Home Interactive Société anonyme's use of debt. 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 1 warning sign for Focus Home Interactive Société anonyme 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. 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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