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David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the 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. We can see that FRIWO AG (ETR:CEA) does use debt in its business. But is this debt a concern to shareholders?
Why Does Debt Bring Risk?
Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. If things get really bad, the lenders can take control of the business. 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. 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.
See our latest analysis for FRIWO
What Is FRIWO's Net Debt?
The image below, which you can click on for greater detail, shows that at June 2019 FRIWO had debt of €21.6m, up from €8.37m in one year. On the flip side, it has €3.80m in cash leading to net debt of about €17.8m.
How Strong Is FRIWO's Balance Sheet?
Zooming in on the latest balance sheet data, we can see that FRIWO had liabilities of €31.0m due within 12 months and liabilities of €10.5m due beyond that. Offsetting these obligations, it had cash of €3.80m as well as receivables valued at €13.2m due within 12 months. So its liabilities total €24.6m more than the combination of its cash and short-term receivables.
Of course, FRIWO has a market capitalization of €174.0m, so these liabilities are probably manageable. But there are sufficient liabilities that we would certainly recommend shareholders continue to monitor the balance sheet, going forward.
We use two main ratios to inform us about debt levels relative to earnings. The first is net debt divided by earnings before interest, tax, depreciation, and amortization (EBITDA), while the second is how many times its earnings before interest and tax (EBIT) covers its interest expense (or its interest cover, for short). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.
FRIWO has a debt to EBITDA ratio of 2.8 and its EBIT covered its interest expense 4.1 times. This suggests that while the debt levels are significant, we'd stop short of calling them problematic. Even worse, FRIWO saw its EBIT tank 60% over the last 12 months. If earnings continue to follow that trajectory, paying off that debt load will be harder than convincing us to run a marathon in the rain. When analysing debt levels, the balance sheet is the obvious place to start. But it is FRIWO's earnings that will influence how the balance sheet holds up in the future. So if you're keen to discover more about its earnings, it might be worth checking out this graph of its long term earnings trend.