Fras-le (BVMF:FRAS3) has a fairly healthy balance sheet
Howard Marks said it well when he said that, rather than worrying about stock price volatility, “the possibility of permanent loss is the risk I worry about…and that every practical investor that I know is worried”. It’s natural to consider a company’s balance sheet when looking at its riskiness, as debt is often involved when a company fails. Above all, Fras-le SA (BVMF:FRAS3) is in debt. But the real question is whether this debt makes the business risky.
Why is debt risky?
Debt and other liabilities become risky for a business when it cannot easily meet those obligations, either with free cash flow or by raising capital at an attractive price. An integral part of capitalism is the process of “creative destruction” where bankrupt companies are mercilessly liquidated by their bankers. However, a more frequent (but still costly) event is when a company has to issue shares at bargain prices, permanently diluting shareholders, just to shore up its balance sheet. That said, the most common situation is when a company manages its debt reasonably well – and to its own benefit. The first step when considering a company’s debt levels is to consider its cash and debt together.
See our latest analysis for Fras-le
What is the Fras-le debt?
As you can see below, Fras-le had a debt of 956.8 million reais in March 2022, roughly the same as the previous year. You can click on the graph for more details. However, he has 308.7 million reais in cash to offset this, resulting in a net debt of around 648.1 million reais.
A look at the responsibilities of Fras-le
We can see from the most recent balance sheet that Fras-le had liabilities of R$732.0 million due in one year, and liabilities of R$1.17 billion due beyond. In compensation for these obligations, it had cash of R$308.7 million as well as receivables valued at R$448.2 million maturing within 12 months. It therefore has liabilities totaling R$1.14 billion more than its cash and short-term receivables, combined.
While that might sound like a lot, it’s not that bad since Fras-le has a market capitalization of R$2.39 billion, so it could probably strengthen its balance sheet by raising capital if needed. But we definitely want to keep our eyes peeled for indications that its debt is too risky.
We measure a company’s leverage against its earning power by looking at its net debt divided by its earnings before interest, taxes, depreciation and amortization (EBITDA) and calculating how easily its earnings before interest and taxes (EBIT ) covers its interest charge (interest coverage). Thus, we consider debt to earnings with and without amortization and depreciation expense.
Fras-le has net debt worth 2.0x EBITDA, which isn’t too much, but its interest coverage looks a little low, with EBIT at just 4.1x operating expenses. ‘interests. While that doesn’t worry us too much, it does suggest that interest payments are a bit of a burden. One way Fras-le could overcome its debt would be to stop borrowing more but continue to grow EBIT to around 16%, as it did last year. There is no doubt that we learn the most about debt from the balance sheet. But ultimately, the company’s future profitability will decide whether Fras-le can strengthen its balance sheet over time. So if you are focused on the future, you can check out this free report showing analyst earnings forecast.
Finally, while the taxman may love accounting profits, lenders only accept cash. It is therefore worth checking how much of this EBIT is supported by free cash flow. Over the past three years, Fras-le has recorded free cash flow of 57% of its EBIT, which is about normal, given that free cash flow excludes interest and taxes. This free cash flow puts the company in a good position to repay its debt, should it arise.
Our point of view
Fras-le’s ability to increase its EBIT and its conversion of EBIT into free cash flow have reinforced our ability to manage its debt. That said, its interest coverage does make us somewhat aware of potential future risks to the balance sheet. When we consider all the factors mentioned above, we feel a bit cautious about Fras-le’s use of debt. While we understand that debt can improve returns on equity, we suggest shareholders keep a close eye on their level of debt, lest it increase. The balance sheet is clearly the area to focus on when analyzing debt. However, not all investment risks reside on the balance sheet, far from it. For example, we have identified 5 warning signs for Fras-le of which you should be aware.
Of course, if you’re the type of investor who prefers to buy stocks without the burden of debt, then feel free to check out our exclusive list of cash-efficient growth stocks today.
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This Simply Wall St article is general in nature. We provide commentary based on historical data and analyst forecasts only using unbiased methodology and our articles are not intended to be financial advice. It is not a recommendation to buy or sell stocks and does not take into account your objectives or financial situation. Our goal is to bring you targeted long-term analysis based on fundamental data. Note that our analysis may not take into account the latest announcements from price-sensitive companies or qualitative materials. Simply Wall St has no position in the stocks mentioned.