Warren Buffett famously said, 'Volatility is far from synonymous with risk.' 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. As with many other companies Forterra plc (LON:FORT) makes use of debt. But the more important question is: how much risk is that debt creating?
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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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.
What Is Forterra's Net Debt?
You can click the graphic below for the historical numbers, but it shows that Forterra had UK£15.5m of debt in December 2020, down from UK£69.8m, one year before. However, it does have UK£31.5m in cash offsetting this, leading to net cash of UK£16.0m.
A Look At Forterra's Liabilities
Zooming in on the latest balance sheet data, we can see that Forterra had liabilities of UK£72.7m due within 12 months and liabilities of UK£31.1m due beyond that. Offsetting this, it had UK£31.5m in cash and UK£36.3m in receivables that were due within 12 months. So its liabilities total UK£36.0m more than the combination of its cash and short-term receivables.
Since publicly traded Forterra shares are worth a total of UK£627.5m, it seems unlikely that this level of liabilities would be a major threat. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time. Despite its noteworthy liabilities, Forterra boasts net cash, so it's fair to say it does not have a heavy debt load!
It is just as well that Forterra's load is not too heavy, because its EBIT was down 66% over the last year. When a company sees its earnings tank, it can sometimes find its relationships with its lenders turn sour. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Forterra 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.
Finally, a company can only pay off debt with cold hard cash, not accounting profits. While Forterra 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, Forterra produced sturdy free cash flow equating to 61% of its EBIT, about what we'd expect. This free cash flow puts the company in a good position to pay down debt, when appropriate.
While it is always sensible to look at a company's total liabilities, it is very reassuring that Forterra has UK£16.0m in net cash. So we are not troubled with Forterra's debt use. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. We've identified 2 warning signs with Forterra , and understanding them should be part of your investment process.
If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.
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