Does F.I.L.A. - Fabbrica Italiana Lapis ed Affini (BIT:FILA) Have A Healthy Balance Sheet?

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. As with many other companies F.I.L.A. - Fabbrica Italiana Lapis ed Affini S.p.A. (BIT:FILA) makes use of debt. But the real question is whether this debt is making the company risky.

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. If things get really bad, the lenders can take control of the business. 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 thing to do when considering how much debt a business uses is to look at its cash and debt together.

Check out our latest analysis for F.I.L.A. - Fabbrica Italiana Lapis ed Affini

What Is F.I.L.A. - Fabbrica Italiana Lapis ed Affini's Debt?

The chart below, which you can click on for greater detail, shows that F.I.L.A. - Fabbrica Italiana Lapis ed Affini had €566.3m in debt in September 2020; about the same as the year before. However, it does have €88.6m in cash offsetting this, leading to net debt of about €477.7m.

How Healthy Is F.I.L.A. - Fabbrica Italiana Lapis ed Affini's Balance Sheet?

We can see from the most recent balance sheet that F.I.L.A. - Fabbrica Italiana Lapis ed Affini had liabilities of €217.1m falling due within a year, and liabilities of €630.6m due beyond that. On the other hand, it had cash of €88.6m and €181.7m worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by €577.4m.

When you consider that this deficiency exceeds the company's €446.1m market capitalization, you might well be inclined to review the balance sheet intently. Hypothetically, extremely heavy dilution would be required if the company were forced to pay down its liabilities by raising capital at the current share price.

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). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

While F.I.L.A. - Fabbrica Italiana Lapis ed Affini's debt to EBITDA ratio (4.8) suggests that it uses some debt, its interest cover is very weak, at 1.8, suggesting high leverage. It seems clear that the cost of borrowing money is negatively impacting returns for shareholders, of late. Worse, F.I.L.A. - Fabbrica Italiana Lapis ed Affini's EBIT was down 32% over the last year. If earnings keep going like that over the long term, it has a snowball's chance in hell of paying off that debt. The balance sheet is clearly the area to focus on when you are analysing debt. But it is future earnings, more than anything, that will determine F.I.L.A. - Fabbrica Italiana Lapis ed Affini's ability to maintain a healthy balance sheet going forward. 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. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. Over the most recent three years, F.I.L.A. - Fabbrica Italiana Lapis ed Affini recorded free cash flow worth 72% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This cold hard cash means it can reduce its debt when it wants to.

Our View

On the face of it, F.I.L.A. - Fabbrica Italiana Lapis ed Affini's interest cover left us tentative about the stock, and its EBIT growth rate was no more enticing than the one empty restaurant on the busiest night of the year. But on the bright side, its conversion of EBIT to free cash flow is a good sign, and makes us more optimistic. We're quite clear that we consider F.I.L.A. - Fabbrica Italiana Lapis ed Affini to be really rather risky, as a result of its balance sheet health. So we're almost as wary of this stock as a hungry kitten is about falling into its owner's fish pond: once bitten, twice shy, as they say. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. Be aware that F.I.L.A. - Fabbrica Italiana Lapis ed Affini is showing 4 warning signs in our investment analysis , and 1 of those is potentially serious...

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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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. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.
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