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Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk. So it seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. We note that Farmer Bros. Co. (NASDAQ:FARM) does have debt on its balance sheet. But the more important question is: how much risk is that debt creating?
What Risk Does Debt Bring?
Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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, 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 think about a company's use of debt, we first look at cash and debt together.
How Much Debt Does Farmer Bros Carry?
As you can see below, at the end of June 2019, Farmer Bros had US$93.8m of debt, up from US$90.0m a year ago. Click the image for more detail. On the flip side, it has US$6.98m in cash leading to net debt of about US$86.9m.
How Strong Is Farmer Bros's Balance Sheet?
The latest balance sheet data shows that Farmer Bros had liabilities of US$96.1m due within a year, and liabilities of US$170.4m falling due after that. Offsetting these obligations, it had cash of US$6.98m as well as receivables valued at US$56.3m due within 12 months. So its liabilities total US$203.2m more than the combination of its cash and short-term receivables.
This deficit is considerable relative to its market capitalization of US$242.7m, so it does suggest shareholders should keep an eye on Farmer Bros's use of debt. This suggests shareholders would heavily diluted if the company needed to shore up its balance sheet in a hurry. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Farmer Bros'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.
In the last year Farmer Bros's revenue was pretty flat, and it made a negative EBIT. While that's not too bad, we'd prefer see growth.
Importantly, Farmer Bros had negative earnings before interest and tax (EBIT), over the last year. Indeed, it lost US$3.2m at the EBIT level. When we look at that and recall the liabilities on its balance sheet, relative to cash, it seems unwise to us for the company to have any debt. Quite frankly we think the balance sheet is far from match-fit, although it could be improved with time. We would feel better if it turned its trailing twelve month loss of US$74m into a profit. So to be blunt we do think it is risky. When I consider a company to be a bit risky, I think it is responsible to check out whether insiders have been reporting any share sales. Luckily, you can click here ito see our graphic depicting Farmer Bros insider transactions.
If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.
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