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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.' 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. As with many other companies. FBL Financial Group, Inc. (NYSE:FFG) makes use of debt. But is this debt a concern to shareholders?
What Risk Does Debt Bring?
Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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. Of course, plenty of companies use debt to fund growth, without any negative consequences. When we examine debt levels, we first consider both cash and debt levels, together.
See our latest analysis for FBL Financial Group
What Is FBL Financial Group's Debt?
You can click the graphic below for the historical numbers, but it shows that as of March 2019 FBL Financial Group had US$101.0m of debt, an increase on US$97.0m, over one year. However, it also had US$17.6m in cash, and so its net debt is US$83.4m.
How Strong Is FBL Financial Group's Balance Sheet?
Zooming in on the latest balance sheet data, we can see that FBL Financial Group had liabilities of US$365.0m due within 12 months and liabilities of US$8.42b due beyond that. On the other hand, it had cash of US$17.6m and US$9.25m worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by US$8.76b.
This deficit casts a shadow over the US$1.55b company, like a colossus towering over mere mortals. So we definitely think shareholders need to watch this one closely. At the end of the day, FBL Financial Group would probably need a major re-capitalization if its creditors were to demand repayment. Because it carries more debt than cash, we think it's worth watching FBL Financial Group's balance sheet over time.
We measure a company's debt load relative to its earnings power by looking at its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and by calculating how easily its earnings before interest and tax (EBIT) cover its interest expense (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).
FBL Financial Group's net debt is only 0.54 times its EBITDA. And its EBIT covers its interest expense a whopping 24.6 times over. So you could argue it is no more threatened by its debt than an elephant is by a mouse. But the bad news is that FBL Financial Group has seen its EBIT plunge 16% in the last twelve months. We think hat kind of performance, if repeated frequently, could well lead to difficulties for the stock. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if FBL Financial Group 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.
But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So it's worth checking how much of that EBIT is backed by free cash flow. Happily for any shareholders, FBL Financial Group actually produced more free cash flow than EBIT over the last three years. That sort of strong cash conversion gets us excited like the crowd when the beat drops at a Daft Punk concert.
Our View
On the face of it, FBL Financial Group's EBIT growth rate left us tentative about the stock, and its level of total liabilities was no more enticing than the one empty restaurant on the busiest night of the year. But on the bright side, its interest cover is a good sign, and makes us more optimistic. Once we consider all the factors above, together, it seems to us that FBL Financial Group's debt is making it a bit risky. That's not necessarily a bad thing, but we'd generally feel more comfortable with less leverage. Another positive for shareholders is that it pays dividends. So if you like receiving those dividend payments, check FBL Financial Group's dividend history, without delay!
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.
We aim to bring you long-term focused research analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material.
If you spot an error that warrants correction, please contact the editor at editorial-team@simplywallst.com. 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. Simply Wall St has no position in the stocks mentioned. Thank you for reading.