Stock Analysis

Is Fnac Darty (EPA:FNAC) A Risky Investment?

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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.' 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 note that Fnac Darty SA (EPA:FNAC) 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?

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 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, plenty of companies use debt to fund growth, without any negative consequences. When we examine debt levels, we first consider both cash and debt levels, together.

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How Much Debt Does Fnac Darty Carry?

The chart below, which you can click on for greater detail, shows that Fnac Darty had €937.0m in debt in December 2022; about the same as the year before. But it also has €951.0m in cash to offset that, meaning it has €14.0m net cash.

ENXTPA:FNAC Debt to Equity History March 14th 2023

How Healthy Is Fnac Darty's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Fnac Darty had liabilities of €3.08b due within 12 months and liabilities of €2.15b due beyond that. Offsetting these obligations, it had cash of €951.0m as well as receivables valued at €256.0m due within 12 months. So it has liabilities totalling €4.02b more than its cash and near-term receivables, combined.

This deficit casts a shadow over the €957.5m company, like a colossus towering over mere mortals. So we'd watch its balance sheet closely, without a doubt. At the end of the day, Fnac Darty would probably need a major re-capitalization if its creditors were to demand repayment. Given that Fnac Darty has more cash than debt, we're pretty confident it can handle its debt, despite the fact that it has a lot of liabilities in total.

Unfortunately, Fnac Darty's EBIT flopped 15% over the last four quarters. If that sort of decline is not arrested, then the managing its debt will be harder than selling broccoli flavoured ice-cream for a premium. 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 Fnac Darty 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. While Fnac Darty 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. Happily for any shareholders, Fnac Darty actually produced more free cash flow than EBIT over the last three years. There's nothing better than incoming cash when it comes to staying in your lenders' good graces.

Summing Up

Although Fnac Darty's balance sheet isn't particularly strong, due to the total liabilities, it is clearly positive to see that it has net cash of €14.0m. And it impressed us with free cash flow of €223m, being 147% of its EBIT. Despite its cash we think that Fnac Darty seems to struggle to handle its total liabilities, so we are wary of the stock. 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. For example, we've discovered 2 warning signs for Fnac Darty that you should be aware of before investing here.

At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.

Valuation is complex, but we're helping make it simple.

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