Warren Buffett famously said, ‘Volatility is far from synonymous with risk.’ So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. We note that Future Market Networks Limited (NSE:FMNL) does have debt on its balance sheet. But is this debt a concern to shareholders?
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. If things get really bad, the lenders can take control of the business. 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. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. The first step when considering a company’s debt levels is to consider its cash and debt together.
What Is Future Market Networks’s Debt?
As you can see below, Future Market Networks had ₹1.17b of debt at March 2019, down from ₹2.38b a year prior. However, it does have ₹64.7m in cash offsetting this, leading to net debt of about ₹1.11b.
How Healthy Is Future Market Networks’s Balance Sheet?
Zooming in on the latest balance sheet data, we can see that Future Market Networks had liabilities of ₹4.09b due within 12 months and liabilities of ₹264.5m due beyond that. Offsetting these obligations, it had cash of ₹64.7m as well as receivables valued at ₹932.6m due within 12 months. So it has liabilities totalling ₹3.35b more than its cash and near-term receivables, combined.
The deficiency here weighs heavily on the ₹1.82b company itself, as if a child were struggling under the weight of an enormous back-pack full of books, his sports gear, and a trumpet. So we definitely think shareholders need to watch this one closely. After all, Future Market Networks would likely require a major re-capitalisation if it had to pay its creditors today.
We use two main ratios to inform us about debt levels relative to earnings. The first is net debt divided by earnings before interest, tax, depreciation, and amortization (EBITDA), while the second is how many times its earnings before interest and tax (EBIT) covers its interest expense (or its interest cover, for short). The advantage of this approach is that we take into account both the absolute quantum of debt (with net debt to EBITDA) and the actual interest expenses associated with that debt (with its interest cover ratio).
While Future Market Networks has a quite reasonable net debt to EBITDA multiple of 2.2, its interest cover seems weak, at 0.77. In large part that’s it has so much depreciation and amortisation. These charges may be non-cash, so they could be excluded when it comes to paying down debt. But the accounting charges are there for a reason — some assets are seen to be losing value. In any case, it’s safe to say the company has meaningful debt. We also note that Future Market Networks improved its EBIT from a last year’s loss to a positive ₹176m. The balance sheet is clearly the area to focus on when you are analysing debt. But it is Future Market Networks’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.
But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So it’s worth checking how much of the earnings before interest and tax (EBIT) is backed by free cash flow. During the last year, Future Market Networks generated free cash flow amounting to a very robust 88% of its EBIT, more than we’d expect. That positions it well to pay down debt if desirable to do so.
On the face of it, Future Market Networks’s interest cover left us tentative about the stock, and its level of total liabilities was no more enticing than the one empty restaurant on the busiest night of the year. But at least it’s pretty decent at converting EBIT to free cash flow; that’s encouraging. Looking at the bigger picture, it seems clear to us that Future Market Networks’s use of debt is creating risks for the company. If everything goes well that may pay off but the downside of this debt is a greater risk of permanent losses. Over time, share prices tend to follow earnings per share, so if you’re interested in Future Market Networks, you may well want to click here to check an interactive graph of its earnings per share history.
If you’re interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.
We aim to bring you long-term focused research analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material.
If you spot an error that warrants correction, please contact the editor at firstname.lastname@example.org. This article by Simply Wall St is general in nature. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. Simply Wall St has no position in the stocks mentioned. Thank you for reading.