F.I.L.A. - Fabbrica Italiana Lapis ed Affini (BIT:FILA) Has A Somewhat Strained Balance Sheet

Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' 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 F.I.L.A. - Fabbrica Italiana Lapis ed Affini S.p.A. (BIT:FILA) does have debt on its balance sheet. But should shareholders be worried about its use of debt?

When Is Debt A Problem?

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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.

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

How Much Debt Does F.I.L.A. - Fabbrica Italiana Lapis ed Affini Carry?

You can click the graphic below for the historical numbers, but it shows that F.I.L.A. - Fabbrica Italiana Lapis ed Affini had €319.4m of debt in September 2024, down from €439.1m, one year before. However, it also had €55.8m in cash, and so its net debt is €263.7m.

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

The latest balance sheet data shows that F.I.L.A. - Fabbrica Italiana Lapis ed Affini had liabilities of €150.9m due within a year, and liabilities of €396.5m falling due after that. Offsetting these obligations, it had cash of €55.8m as well as receivables valued at €157.9m due within 12 months. So its liabilities total €333.7m more than the combination of its cash and short-term receivables.

This is a mountain of leverage relative to its market capitalization of €530.6m. Should its lenders demand that it shore up the balance sheet, shareholders would likely face severe dilution.

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). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

F.I.L.A. - Fabbrica Italiana Lapis ed Affini has net debt worth 2.3 times EBITDA, which isn't too much, but its interest cover looks a bit on the low side, with EBIT at only 3.3 times the interest expense. While these numbers do not alarm us, it's worth noting that the cost of the company's debt is having a real impact. Unfortunately, F.I.L.A. - Fabbrica Italiana Lapis ed Affini saw its EBIT slide 7.0% in the last twelve months. If earnings continue on that decline then managing that debt will be difficult like delivering hot soup on a unicycle. 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 F.I.L.A. - Fabbrica Italiana Lapis ed Affini can strengthen its balance sheet over time. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. During the last three years, F.I.L.A. - Fabbrica Italiana Lapis ed Affini generated free cash flow amounting to a very robust 92% of its EBIT, more than we'd expect. That puts it in a very strong position to pay down debt.

Our View

Neither F.I.L.A. - Fabbrica Italiana Lapis ed Affini's ability to cover its interest expense with its EBIT nor its EBIT growth rate gave us confidence in its ability to take on more debt. But the good news is it seems to be able to convert EBIT to free cash flow with ease. Looking at all the angles mentioned above, it does seem to us that F.I.L.A. - Fabbrica Italiana Lapis ed Affini is a somewhat risky investment as a result of its debt. Not all risk is bad, as it can boost share price returns if it pays off, but this debt risk is worth keeping in mind. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. For example F.I.L.A. - Fabbrica Italiana Lapis ed Affini has 3 warning signs (and 1 which doesn't sit too well with us) we think you should know about.

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.

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This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. 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.