Health Check: How Prudently Does Farfetch (NYSE:FTCH) Use Debt?

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.' 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. As with many other companies Farfetch Limited (NYSE:FTCH) makes use of debt. But should shareholders be worried about its use of debt?

When Is Debt Dangerous?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. When we examine debt levels, we first consider both cash and debt levels, together.

Check out our latest analysis for Farfetch

How Much Debt Does Farfetch Carry?

The image below, which you can click on for greater detail, shows that Farfetch had debt of US$515.8m at the end of December 2021, a reduction from US$635.2m over a year. But on the other hand it also has US$1.46b in cash, leading to a US$947.3m net cash position.

How Healthy Is Farfetch's Balance Sheet?

According to the last reported balance sheet, Farfetch had liabilities of US$907.3m due within 12 months, and liabilities of US$2.65b due beyond 12 months. Offsetting this, it had US$1.46b in cash and US$384.9m in receivables that were due within 12 months. So its liabilities total US$1.71b more than the combination of its cash and short-term receivables.

Farfetch has a market capitalization of US$6.34b, so it could very likely raise cash to ameliorate its balance sheet, if the need arose. But it's clear that we should definitely closely examine whether it can manage its debt without dilution. Despite its noteworthy liabilities, Farfetch boasts net cash, so it's fair to say it does not have a heavy debt load! 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 Farfetch 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.

Over 12 months, Farfetch reported revenue of US$2.3b, which is a gain of 35%, although it did not report any earnings before interest and tax. Shareholders probably have their fingers crossed that it can grow its way to profits.

So How Risky Is Farfetch?

Although Farfetch had an earnings before interest and tax (EBIT) loss over the last twelve months, it made a statutory profit of US$1.5b. So taking that on face value, and considering the cash, we don't think its very risky in the near term. One positive is that Farfetch is growing revenue apace, which makes it easier to sell a growth story and raise capital if need be. But that doesn't change our opinion that the stock is risky. 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. We've identified 3 warning signs with Farfetch (at least 1 which is a bit unpleasant) , and understanding them should be part of your investment process.

When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.

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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.