Is ForFarmers (AMS:FFARM) A Risky Investment?

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. We can see that ForFarmers N.V. (AMS:FFARM) does use debt in its business. But the real question is whether this debt is making the company risky.

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. 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. When we examine debt levels, we first consider both cash and debt levels, together.

See our latest analysis for ForFarmers

What Is ForFarmers's Net Debt?

As you can see below, ForFarmers had €52.9m of debt at December 2020, down from €69.8m a year prior. However, its balance sheet shows it holds €68.7m in cash, so it actually has €15.8m net cash.

How Healthy Is ForFarmers' Balance Sheet?

Zooming in on the latest balance sheet data, we can see that ForFarmers had liabilities of €321.7m due within 12 months and liabilities of €132.5m due beyond that. Offsetting these obligations, it had cash of €68.7m as well as receivables valued at €219.1m due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by €166.4m.

ForFarmers has a market capitalization of €513.9m, so it could very likely raise cash to ameliorate its balance sheet, if the need arose. However, it is still worthwhile taking a close look at its ability to pay off debt. Despite its noteworthy liabilities, ForFarmers boasts net cash, so it's fair to say it does not have a heavy debt load!

Another good sign is that ForFarmers has been able to increase its EBIT by 22% in twelve months, making it easier to pay down 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 ForFarmers'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. ForFarmers may have net cash on the balance sheet, but it is still interesting to look at how well the business converts its earnings before interest and tax (EBIT) to free cash flow, because that will influence both its need for, and its capacity to manage debt. Over the last three years, ForFarmers recorded free cash flow worth a fulsome 96% of its EBIT, which is stronger than we'd usually expect. That positions it well to pay down debt if desirable to do so.

Summing up

Although ForFarmers's balance sheet isn't particularly strong, due to the total liabilities, it is clearly positive to see that it has net cash of €15.8m. The cherry on top was that in converted 96% of that EBIT to free cash flow, bringing in €62m. So is ForFarmers's debt a risk? It doesn't seem so to us. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. We've identified 2 warning signs with ForFarmers , and understanding them should be part of your investment process.

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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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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