Is Farmer Bros (NASDAQ:FARM) Using Too Much Debt?

Warren Buffett famously said, 'Volatility is far from synonymous with risk.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. We note that Farmer Bros. Co. (NASDAQ:FARM) does have debt on its balance sheet. But is this debt a concern to shareholders?

Why Does Debt Bring Risk?

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. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. The first step when considering a company's debt levels is to consider its cash and debt together.

Check out our latest analysis for Farmer Bros

How Much Debt Does Farmer Bros Carry?

You can click the graphic below for the historical numbers, but it shows that as of December 2020 Farmer Bros had US$85.6m of debt, an increase on US$71.4m, over one year. However, because it has a cash reserve of US$5.86m, its net debt is less, at about US$79.7m.

How Healthy Is Farmer Bros' Balance Sheet?

We can see from the most recent balance sheet that Farmer Bros had liabilities of US$81.5m falling due within a year, and liabilities of US$178.4m due beyond that. On the other hand, it had cash of US$5.86m and US$41.9m worth of receivables due within a year. So its liabilities total US$212.2m more than the combination of its cash and short-term receivables.

When you consider that this deficiency exceeds the company's US$172.5m market capitalization, you might well be inclined to review the balance sheet intently. In the scenario where the company had to clean up its balance sheet quickly, it seems likely shareholders would suffer extensive dilution. 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 had a loss before interest and tax, and actually shrunk its revenue by 29%, to US$412m. To be frank that doesn't bode well.

Caveat Emptor

Not only did Farmer Bros's revenue slip over the last twelve months, but it also produced negative earnings before interest and tax (EBIT). Indeed, it lost US$15m at the EBIT level. Considering that alongside the liabilities mentioned above make us nervous 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$18m 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. However, not all investment risk resides within the balance sheet - far from it. To that end, you should learn about the 5 warning signs we've spotted with Farmer Bros (including 1 which can't be ignored) .

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. 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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