Is Feerum (WSE:FEE) A Risky Investment?

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.' 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 Feerum S.A. (WSE:FEE) does use debt in its business. But is this debt a concern to shareholders?

When Is Debt Dangerous?

Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we think about a company's use of debt, we first look at cash and debt together.

See our latest analysis for Feerum

What Is Feerum's Debt?

You can click the graphic below for the historical numbers, but it shows that Feerum had zł51.4m of debt in June 2020, down from zł69.0m, one year before. However, it also had zł32.8m in cash, and so its net debt is zł18.6m.

A Look At Feerum's Liabilities

The latest balance sheet data shows that Feerum had liabilities of zł102.2m due within a year, and liabilities of zł18.5m falling due after that. Offsetting these obligations, it had cash of zł32.8m as well as receivables valued at zł63.4m due within 12 months. So it has liabilities totalling zł24.5m more than its cash and near-term receivables, combined.

While this might seem like a lot, it is not so bad since Feerum has a market capitalization of zł108.7m, and so it could probably strengthen its balance sheet by raising capital if it needed to. But it's clear that we should definitely closely examine whether it can manage its debt without 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.

Feerum has a low net debt to EBITDA ratio of only 0.64. And its EBIT covers its interest expense a whopping 20.2 times over. So we're pretty relaxed about its super-conservative use of debt. On top of that, Feerum grew its EBIT by 84% over the last twelve months, and that growth will make it easier to handle its debt. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since Feerum will need earnings to service that debt. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. In the last three years, Feerum's free cash flow amounted to 24% of its EBIT, less than we'd expect. That's not great, when it comes to paying down debt.

Our View

Feerum's interest cover suggests it can handle its debt as easily as Cristiano Ronaldo could score a goal against an under 14's goalkeeper. But truth be told we feel its conversion of EBIT to free cash flow does undermine this impression a bit. When we consider the range of factors above, it looks like Feerum is pretty sensible with its use of debt. That means they are taking on a bit more risk, in the hope of boosting shareholder returns. 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. For example, we've discovered 2 warning signs for Feerum that you should be aware of before investing here.

When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.

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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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