Yahoo Finance Is Finsbury Food Group (LON:FIF) Using Too Much Debt?
Warren Buffett famously said, 'Volatility is far from synonymous with risk.' 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. We can see that Finsbury Food Group Plc (LON:FIF) does use debt in its business. But should shareholders be worried about its use of debt?
When Is Debt A Problem?
Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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, debt can be an important tool in businesses, particularly capital heavy businesses. When we think about a company's use of debt, we first look at cash and debt together.
See our latest analysis for Finsbury Food Group
What Is Finsbury Food Group's Debt?
You can click the graphic below for the historical numbers, but it shows that as of December 2018 Finsbury Food Group had UK£46.5m of debt, an increase on UK£20.7m, over one year. However, it does have UK£10.7m in cash offsetting this, leading to net debt of about UK£35.8m.
A Look At Finsbury Food Group's Liabilities
We can see from the most recent balance sheet that Finsbury Food Group had liabilities of UK£113.1m falling due within a year, and liabilities of UK£17.6m due beyond that. Offsetting this, it had UK£10.7m in cash and UK£52.2m in receivables that were due within 12 months. So it has liabilities totalling UK£67.8m more than its cash and near-term receivables, combined.
This is a mountain of leverage relative to its market capitalization of UK£83.2m. This suggests shareholders would heavily diluted if the company needed to shore up its balance sheet in a hurry.
In order to size up a company's debt relative to its earnings, we calculate its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and its earnings before interest and tax (EBIT) divided by its interest expense (its 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).
Finsbury Food Group has a low net debt to EBITDA ratio of only 1.3. And its EBIT easily covers its interest expense, being 30.8 times the size. So you could argue it is no more threatened by its debt than an elephant is by a mouse. While Finsbury Food Group doesn't seem to have gained much on the EBIT line, at least earnings remain stable for now. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Finsbury Food Group's ability to maintain a healthy balance sheet going forward. So if you're focused on the future you can check out this free report showing analyst profit forecasts.
Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. In the last three years, Finsbury Food Group's free cash flow amounted to 30% of its EBIT, less than we'd expect. That's not great, when it comes to paying down debt.
Our View
Finsbury Food Group's level of total liabilities and conversion of EBIT to free cash flow definitely weigh on it, in our esteem. But its interest cover tells a very different story, and suggests some resilience. When we consider all the factors discussed, it seems to us that Finsbury Food Group is taking some risks with its use of debt. So while that leverage does boost returns on equity, we wouldn't really want to see it increase from here. In light of our reservations about the company's balance sheet, it seems sensible to check if insiders have been selling shares recently.
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.
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