Ferrexpo (LON:FXPO) Seems To Use Debt Rather Sparingly

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 can see that Ferrexpo plc (LON:FXPO) does use debt in its business. But the real question is whether this debt is making the company risky.

What Risk Does Debt Bring?

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. 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. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. When we think about a company's use of debt, we first look at cash and debt together.

Check out our latest analysis for Ferrexpo

What Is Ferrexpo's Net Debt?

As you can see below, Ferrexpo had US$257.4m of debt at December 2020, down from US$402.3m a year prior. However, it does have US$270.0m in cash offsetting this, leading to net cash of US$12.6m.

How Healthy Is Ferrexpo's Balance Sheet?

We can see from the most recent balance sheet that Ferrexpo had liabilities of US$295.9m falling due within a year, and liabilities of US$167.6m due beyond that. Offsetting this, it had US$270.0m in cash and US$185.4m in receivables that were due within 12 months. So its total liabilities are just about perfectly matched by its shorter-term, liquid assets.

This state of affairs indicates that Ferrexpo's balance sheet looks quite solid, as its total liabilities are just about equal to its liquid assets. So while it's hard to imagine that the US$3.10b company is struggling for cash, we still think it's worth monitoring its balance sheet. Despite its noteworthy liabilities, Ferrexpo boasts net cash, so it's fair to say it does not have a heavy debt load!

Also positive, Ferrexpo grew its EBIT by 27% 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 it is future earnings, more than anything, that will determine Ferrexpo's ability to maintain a healthy balance sheet going forward. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. While Ferrexpo 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, Ferrexpo produced sturdy free cash flow equating to 52% of its EBIT, about what we'd expect. This cold hard cash means it can reduce its debt when it wants to.

Summing up

We could understand if investors are concerned about Ferrexpo's liabilities, but we can be reassured by the fact it has has net cash of US$12.6m. And we liked the look of last year's 27% year-on-year EBIT growth. So we don't think Ferrexpo's use of debt is risky. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. For example, we've discovered 3 warning signs for Ferrexpo (1 doesn't sit too well with us!) 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.

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