We Think Ferrari (NYSE:RACE) Can Stay On Top Of Its Debt

Warren Buffett famously said, 'Volatility is far from synonymous with risk.' 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 can see that Ferrari N.V. (NYSE:RACE) does use debt in its business. But the more important question is: how much risk is that debt creating?

Why Does Debt Bring Risk?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. If things get really bad, the lenders can take control of the business. 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. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. When we examine debt levels, we first consider both cash and debt levels, together.

See our latest analysis for Ferrari

What Is Ferrari's Debt?

You can click the graphic below for the historical numbers, but it shows that as of September 2024 Ferrari had €2.96b of debt, an increase on €2.46b, over one year. However, it does have €1.50b in cash offsetting this, leading to net debt of about €1.46b.

A Look At Ferrari's Liabilities

We can see from the most recent balance sheet that Ferrari had liabilities of €3.00b falling due within a year, and liabilities of €2.64b due beyond that. Offsetting these obligations, it had cash of €1.50b as well as receivables valued at €308.2m due within 12 months. So it has liabilities totalling €3.84b more than its cash and near-term receivables, combined.

Given Ferrari has a humongous market capitalization of €75.7b, it's hard to believe these liabilities pose much threat. But there are sufficient liabilities that we would certainly recommend shareholders continue to monitor the balance sheet, going forward.

In order to size up a company's debt relative to its earnings, we calculate its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and its earnings before interest and tax (EBIT) divided by its interest expense (its interest cover). The advantage of this approach is that we take into account both the absolute quantum of debt (with net debt to EBITDA) and the actual interest expenses associated with that debt (with its interest cover ratio).

Ferrari's net debt is only 0.70 times its EBITDA. And its EBIT easily covers its interest expense, being 281 times the size. So you could argue it is no more threatened by its debt than an elephant is by a mouse. And we also note warmly that Ferrari grew its EBIT by 16% last year, making its debt load easier to handle. There's no doubt that we learn most about debt from the balance sheet. But ultimately the future profitability of the business will decide if Ferrari 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.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. So it's worth checking how much of that EBIT is backed by free cash flow. Over the most recent three years, Ferrari recorded free cash flow worth 51% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This free cash flow puts the company in a good position to pay down debt, when appropriate.

Our View

Happily, Ferrari's impressive interest cover implies it has the upper hand on its debt. And the good news does not stop there, as its net debt to EBITDA also supports that impression! Looking at the bigger picture, we think Ferrari's use of debt seems quite reasonable and we're not concerned about it. After all, sensible leverage can boost returns on equity. 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. Be aware that Ferrari is showing 1 warning sign in our investment analysis , you should know about...

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

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.