First Property Group (LON:FPO) Has A Somewhat Strained Balance Sheet

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.' So it seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. Importantly, First Property Group plc (LON:FPO) does carry debt. But the more important question is: how much risk is that debt creating?

What Risk Does Debt Bring?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. The first step when considering a company's debt levels is to consider its cash and debt together.

See our latest analysis for First Property Group

What Is First Property Group's Debt?

As you can see below, First Property Group had UK£16.5m of debt at September 2020, down from UK£40.9m a year prior. However, it does have UK£21.2m in cash offsetting this, leading to net cash of UK£4.66m.

A Look At First Property Group's Liabilities

Zooming in on the latest balance sheet data, we can see that First Property Group had liabilities of UK£31.3m due within 12 months and liabilities of UK£18.9m due beyond that. Offsetting this, it had UK£21.2m in cash and UK£2.76m in receivables that were due within 12 months. So it has liabilities totalling UK£26.3m more than its cash and near-term receivables, combined.

This deficit is considerable relative to its market capitalization of UK£40.3m, so it does suggest shareholders should keep an eye on First Property Group's use of debt. Should its lenders demand that it shore up the balance sheet, shareholders would likely face severe dilution. Despite its noteworthy liabilities, First Property Group boasts net cash, so it's fair to say it does not have a heavy debt load!

Importantly, First Property Group's EBIT fell a jaw-dropping 32% in the last twelve months. If that earnings trend continues then paying off its debt will be about as easy as herding cats on to a roller coaster. 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 First Property Group 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 First Property Group 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, First Property Group actually produced more free cash flow than EBIT over the last three years. That sort of strong cash generation warms our hearts like a puppy in a bumblebee suit.

Summing up

While First Property Group does have more liabilities than liquid assets, it also has net cash of UK£4.66m. The cherry on top was that in converted 351% of that EBIT to free cash flow, bringing in UK£43m. So although we see some areas for improvement, we're not too worried about First Property Group's balance sheet. 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. Take risks, for example - First Property Group has 4 warning signs (and 1 which can't be ignored) we think you should know about.

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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