Here's Why Farminveste S.G.P.S (ELI:MLFMV) Is Weighed Down By Its Debt Load

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 Farminveste, S.G.P.S., S.A. (ELI:MLFMV) makes use of debt. But is this debt a concern to shareholders?

Why Does Debt Bring Risk?

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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. Of course, plenty of companies use debt to fund growth, without any negative consequences. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

View our latest analysis for Farminveste S.G.P.S

How Much Debt Does Farminveste S.G.P.S Carry?

As you can see below, Farminveste S.G.P.S had €251.7m of debt at June 2021, down from €262.7m a year prior. On the flip side, it has €19.8m in cash leading to net debt of about €231.9m.

A Look At Farminveste S.G.P.S' Liabilities

According to the last reported balance sheet, Farminveste S.G.P.S had liabilities of €302.1m due within 12 months, and liabilities of €133.6m due beyond 12 months. Offsetting these obligations, it had cash of €19.8m as well as receivables valued at €118.1m due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by €297.8m.

The deficiency here weighs heavily on the €36.2m company itself, as if a child were struggling under the weight of an enormous back-pack full of books, his sports gear, and a trumpet. So we definitely think shareholders need to watch this one closely. At the end of the day, Farminveste S.G.P.S would probably need a major re-capitalization if its creditors were to demand repayment.

We measure a company's debt load relative to its earnings power by looking at its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and by calculating how easily its earnings before interest and tax (EBIT) cover its interest expense (interest cover). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

Weak interest cover of 1.3 times and a disturbingly high net debt to EBITDA ratio of 11.7 hit our confidence in Farminveste S.G.P.S like a one-two punch to the gut. This means we'd consider it to have a heavy debt load. Worse, Farminveste S.G.P.S's EBIT was down 54% over the last year. If earnings continue to follow that trajectory, paying off that debt load will be harder than convincing us to run a marathon in the rain. There's no doubt that we learn most about debt from the balance sheet. But it is Farminveste S.G.P.S's earnings that will influence how the balance sheet holds up in the future. 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 always check how much of that EBIT is translated into free cash flow. Looking at the most recent three years, Farminveste S.G.P.S recorded free cash flow of 34% of its EBIT, which is weaker than we'd expect. That's not great, when it comes to paying down debt.

Our View

To be frank both Farminveste S.G.P.S's EBIT growth rate and its track record of staying on top of its total liabilities make us rather uncomfortable with its debt levels. But at least its conversion of EBIT to free cash flow is not so bad. We should also note that Healthcare industry companies like Farminveste S.G.P.S commonly do use debt without problems. Taking into account all the aforementioned factors, it looks like Farminveste S.G.P.S has too much debt. While some investors love that sort of risky play, it's certainly not our cup of tea. 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. To that end, you should learn about the 3 warning signs we've spotted with Farminveste S.G.P.S (including 2 which don't sit too well with us) .

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.

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.

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