Flour Mills Kepenos (ATH:KEPEN) Has A Pretty Healthy Balance Sheet

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 Flour Mills Kepenos S.A. (ATH:KEPEN) 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. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

View our latest analysis for Flour Mills Kepenos

What Is Flour Mills Kepenos's Net Debt?

The image below, which you can click on for greater detail, shows that Flour Mills Kepenos had debt of €11.5m at the end of June 2020, a reduction from €13.9m over a year. On the flip side, it has €5.73m in cash leading to net debt of about €5.74m.

A Look At Flour Mills Kepenos's Liabilities

The latest balance sheet data shows that Flour Mills Kepenos had liabilities of €6.30m due within a year, and liabilities of €13.3m falling due after that. On the other hand, it had cash of €5.73m and €15.0m worth of receivables due within a year. So it can boast €1.12m more liquid assets than total liabilities.

This short term liquidity is a sign that Flour Mills Kepenos could probably pay off its debt with ease, as its balance sheet is far from stretched.

We measure a company's debt load relative to its earnings power by looking at its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and by calculating how easily its earnings before interest and tax (EBIT) cover its interest expense (interest cover). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

Flour Mills Kepenos's net debt is sitting at a very reasonable 2.2 times its EBITDA, while its EBIT covered its interest expense just 5.1 times last year. While these numbers do not alarm us, it's worth noting that the cost of the company's debt is having a real impact. We saw Flour Mills Kepenos grow its EBIT by 6.7% in the last twelve months. That's far from incredible but it is a good thing, when it comes to paying off debt. When analysing debt levels, the balance sheet is the obvious place to start. But it is Flour Mills Kepenos's earnings that will influence how the balance sheet holds up in the future. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. Over the last three years, Flour Mills Kepenos barely recorded positive free cash flow, in total. While many companies do operate at break-even, we prefer see substantial free cash flow, especially if a it already has dead.

Our View

Based on what we've seen Flour Mills Kepenos is not finding it easy, given its conversion of EBIT to free cash flow, but the other factors we considered give us cause to be optimistic. In particular, we thought its level of total liabilities was a positive. When we consider all the factors mentioned above, we do feel a bit cautious about Flour Mills Kepenos's use of debt. While we appreciate debt can enhance returns on equity, we'd suggest that shareholders keep close watch on its debt levels, lest they increase. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. Take risks, for example - Flour Mills Kepenos has 4 warning signs (and 1 which is significant) we think you should know about.

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

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