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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. 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. We can see that Franchise Brands plc (LON:FRAN) does use debt in its business. But the more important question is: how much risk is that debt creating?
When Is Debt A Problem?
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. 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, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. When we examine debt levels, we first consider both cash and debt levels, together.
See our latest analysis for Franchise Brands
What Is Franchise Brands's Debt?
As you can see below, Franchise Brands had UK£7.34m of debt at June 2019, down from UK£8.22m a year prior. However, it does have UK£2.76m in cash offsetting this, leading to net debt of about UK£4.58m.
A Look At Franchise Brands's Liabilities
We can see from the most recent balance sheet that Franchise Brands had liabilities of UK£13.1m falling due within a year, and liabilities of UK£5.41m due beyond that. On the other hand, it had cash of UK£2.76m and UK£12.2m worth of receivables due within a year. So it has liabilities totalling UK£3.57m more than its cash and near-term receivables, combined.
Since publicly traded Franchise Brands shares are worth a total of UK£65.2m, it seems unlikely that this level of liabilities would be a major threat. Having said that, it's clear that we should continue to monitor its balance sheet, lest it change for the worse.
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). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.
Franchise Brands has a low net debt to EBITDA ratio of only 1.1. And its EBIT covers its interest expense a whopping 12.5 times over. So we're pretty relaxed about its super-conservative use of debt. Also positive, Franchise Brands grew its EBIT by 23% in the last year, and that should make it easier to pay down debt, going forward. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately the future profitability of the business will decide if Franchise Brands 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.