Health Check: How Prudently Does Farmer Bros (NASDAQ:FARM) Use Debt?

David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the permanent loss of capital.' 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. Importantly, Farmer Bros. Co. (NASDAQ:FARM) does carry debt. But should shareholders be worried about its use of debt?

Why Does Debt Bring Risk?

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. 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. 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. The first step when considering a company's debt levels is to consider its cash and debt together.

See our latest analysis for Farmer Bros

What Is Farmer Bros's Net Debt?

The image below, which you can click on for greater detail, shows that at September 2022 Farmer Bros had debt of US$113.0m, up from US$89.7m in one year. However, it does have US$8.69m in cash offsetting this, leading to net debt of about US$104.3m.

A Look At Farmer Bros' Liabilities

The latest balance sheet data shows that Farmer Bros had liabilities of US$78.8m due within a year, and liabilities of US$163.6m falling due after that. On the other hand, it had cash of US$8.69m and US$47.3m worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by US$186.4m.

The deficiency here weighs heavily on the US$105.3m 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, Farmer Bros would probably need a major re-capitalization if its creditors were to demand repayment. 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 Farmer Bros can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

In the last year Farmer Bros wasn't profitable at an EBIT level, but managed to grow its revenue by 18%, to US$482m. That rate of growth is a bit slow for our taste, but it takes all types to make a world.

Caveat Emptor

Over the last twelve months Farmer Bros produced an earnings before interest and tax (EBIT) loss. Its EBIT loss was a whopping US$25m. When we look at that alongside the significant liabilities, we're not particularly confident about the company. It would need to improve its operations quickly for us to be interested in it. Not least because it burned through US$34m in negative free cash flow over the last year. So suffice it to say we consider the stock to be risky. 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. To that end, you should learn about the 4 warning signs we've spotted with Farmer Bros (including 1 which makes us a bit uncomfortable) .

At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.

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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.