Stock Analysis

We Think Franchise Brands (LON:FRAN) Can Manage Its Debt With Ease

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AIM:FRAN
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Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' 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 Franchise Brands plc (LON:FRAN) does have debt on its balance sheet. But should shareholders be worried about its use of debt?

When Is Debt A Problem?

Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. 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.

See our latest analysis for Franchise Brands

How Much Debt Does Franchise Brands Carry?

As you can see below, Franchise Brands had UK£5.11m of debt at December 2020, down from UK£9.27m a year prior. However, it does have UK£13.2m in cash offsetting this, leading to net cash of UK£8.10m.

debt-equity-history-analysis
AIM:FRAN Debt to Equity History May 23rd 2021

How Strong Is Franchise Brands' Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Franchise Brands had liabilities of UK£14.4m due within 12 months and liabilities of UK£10.3m due beyond that. Offsetting these obligations, it had cash of UK£13.2m as well as receivables valued at UK£15.1m due within 12 months. So it actually has UK£3.57m more liquid assets than total liabilities.

This short term liquidity is a sign that Franchise Brands could probably pay off its debt with ease, as its balance sheet is far from stretched. Succinctly put, Franchise Brands boasts net cash, so it's fair to say it does not have a heavy debt load!

And we also note warmly that Franchise Brands grew its EBIT by 19% last year, making its debt load easier to handle. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Franchise Brands 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, while the tax-man may adore accounting profits, lenders only accept cold hard cash. While Franchise Brands 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. During the last three years, Franchise Brands generated free cash flow amounting to a very robust 84% of its EBIT, more than we'd expect. That puts it in a very strong position to pay down debt.

Summing up

While it is always sensible to investigate a company's debt, in this case Franchise Brands has UK£8.10m in net cash and a decent-looking balance sheet. And it impressed us with free cash flow of UK£4.5m, being 84% of its EBIT. So is Franchise Brands's debt a risk? It doesn't seem so to us. Another factor that would give us confidence in Franchise Brands would be if insiders have been buying shares: if you're conscious of that signal too, you can find out instantly by clicking this link.

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.

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