Is Farmer Bros (NASDAQ:FARM) Weighed On By Its Debt Load?

The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' So it seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. As with many other companies Farmer Bros. Co. (NASDAQ:FARM) makes use of debt. But should shareholders be worried about its use of debt?

What Risk Does Debt Bring?

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. 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.

See our latest analysis for Farmer Bros

What Is Farmer Bros's Debt?

As you can see below, at the end of March 2021, Farmer Bros had US$91.0m of debt, up from US$83.9m a year ago. Click the image for more detail. On the flip side, it has US$8.47m in cash leading to net debt of about US$82.5m.

How Strong Is Farmer Bros' Balance Sheet?

According to the last reported balance sheet, Farmer Bros had liabilities of US$74.4m due within 12 months, and liabilities of US$183.9m due beyond 12 months. Offsetting this, it had US$8.47m in cash and US$37.1m in receivables that were due within 12 months. So its liabilities total US$212.7m more than the combination of its cash and short-term receivables.

When you consider that this deficiency exceeds the company's US$155.6m market capitalization, you might well be inclined to review the balance sheet intently. Hypothetically, extremely heavy dilution would be required if the company were forced to pay down its liabilities by raising capital at the current share price. The balance sheet is clearly the area to focus on when you are analysing debt. But it is future earnings, more than anything, that will determine Farmer Bros's ability to maintain a healthy balance sheet going forward. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

In the last year Farmer Bros had a loss before interest and tax, and actually shrunk its revenue by 33%, to US$376m. That makes us nervous, to say the least.

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 a very considerable US$20m at the EBIT level. 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$27m over the last twelve months. That means it's on the risky side of things. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. We've identified 4 warning signs with Farmer Bros (at least 1 which is concerning) , and understanding them should be part of your investment process.

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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