These 4 Measures Indicate That Fabryki Mebli FORTE (WSE:FTE) Is Using Debt Reasonably Well

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 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 Fabryki Mebli FORTE S.A. (WSE:FTE) does have debt on its balance sheet. But should shareholders be worried about its use of debt?

When Is Debt A Problem?

Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. 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. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. When we examine debt levels, we first consider both cash and debt levels, together.

See our latest analysis for Fabryki Mebli FORTE

How Much Debt Does Fabryki Mebli FORTE Carry?

The image below, which you can click on for greater detail, shows that Fabryki Mebli FORTE had debt of zł455.8m at the end of September 2020, a reduction from zł604.6m over a year. However, because it has a cash reserve of zł28.5m, its net debt is less, at about zł427.3m.

How Strong Is Fabryki Mebli FORTE's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Fabryki Mebli FORTE had liabilities of zł420.6m due within 12 months and liabilities of zł326.9m due beyond that. On the other hand, it had cash of zł28.5m and zł184.1m worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by zł534.8m.

While this might seem like a lot, it is not so bad since Fabryki Mebli FORTE has a market capitalization of zł1.12b, and so it could probably strengthen its balance sheet by raising capital if it needed to. But we definitely want to keep our eyes open to indications that its debt is bringing too much risk.

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.

Fabryki Mebli FORTE has net debt to EBITDA of 2.5 suggesting it uses a fair bit of leverage to boost returns. On the plus side, its EBIT was 9.4 times its interest expense, and its net debt to EBITDA, was quite high, at 2.5. Importantly, Fabryki Mebli FORTE grew its EBIT by 61% over the last twelve months, and that growth will make it easier to handle its 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 Fabryki Mebli FORTE's ability to maintain a healthy balance sheet going forward. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So we always check how much of that EBIT is translated into free cash flow. In the last three years, Fabryki Mebli FORTE's free cash flow amounted to 37% of its EBIT, less than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.

Our View

When it comes to the balance sheet, the standout positive for Fabryki Mebli FORTE was the fact that it seems able to grow its EBIT confidently. But the other factors we noted above weren't so encouraging. For example, its net debt to EBITDA makes us a little nervous about its debt. When we consider all the elements mentioned above, it seems to us that Fabryki Mebli FORTE is managing its debt quite well. Having said that, the load is sufficiently heavy that we would recommend any shareholders keep a close eye on it. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. For instance, we've identified 3 warning signs for Fabryki Mebli FORTE that you should be aware of.

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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