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

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. Importantly, Farmer Bros. Co. (NASDAQ:FARM) does carry debt. But is this debt a concern to shareholders?

When Is Debt Dangerous?

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. If things get really bad, the lenders can take control of the business. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we think about a company's use of debt, we first look at cash and debt together.

See our latest analysis for Farmer Bros

What Is Farmer Bros's Net Debt?

You can click the graphic below for the historical numbers, but it shows that Farmer Bros had US$23.3m of debt in September 2023, down from US$113.0m, one year before. On the flip side, it has US$4.04m in cash leading to net debt of about US$19.3m.

How Strong Is Farmer Bros' Balance Sheet?

According to the last reported balance sheet, Farmer Bros had liabilities of US$76.7m due within 12 months, and liabilities of US$63.7m due beyond 12 months. Offsetting this, it had US$4.04m in cash and US$35.0m in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by US$101.3m.

This deficit casts a shadow over the US$50.2m company, like a colossus towering over mere mortals. So we'd watch its balance sheet closely, without a doubt. At the end of the day, Farmer Bros would probably need a major re-capitalization if its creditors were to demand repayment. When analysing debt levels, the balance sheet is the obvious place to start. 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 19%, to US$342m. That rate of growth is a bit slow for our taste, but it takes all types to make a world.

Caveat Emptor

Importantly, Farmer Bros had an earnings before interest and tax (EBIT) loss over the last year. Its EBIT loss was a whopping US$33m. Considering that alongside the liabilities mentioned above make us nervous about the company. We'd want to see some strong near-term improvements before getting too interested in the stock. Not least because it had negative free cash flow of US$16m over the last twelve months. That means it's on the risky side of things. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. For example, we've discovered 5 warning signs for Farmer Bros (1 is potentially serious!) that you should be aware of before investing here.

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

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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.