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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. As with many other companies Franklin Electric Co., Inc. (NASDAQ:FELE) makes use of debt. But should shareholders be worried about its use of debt?
Why Does Debt Bring Risk?
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. If things get really bad, the lenders can take control of the business. 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. 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.
How Much Debt Does Franklin Electric Carry?
As you can see below, Franklin Electric had US$94.3m of debt at September 2020, down from US$173.8m a year prior. But it also has US$114.5m in cash to offset that, meaning it has US$20.2m net cash.
How Healthy Is Franklin Electric's Balance Sheet?
Zooming in on the latest balance sheet data, we can see that Franklin Electric had liabilities of US$187.9m due within 12 months and liabilities of US$201.4m due beyond that. Offsetting this, it had US$114.5m in cash and US$171.8m in receivables that were due within 12 months. So its liabilities total US$102.9m more than the combination of its cash and short-term receivables.
Given Franklin Electric has a market capitalization of US$3.34b, it's hard to believe these liabilities pose much threat. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time. Despite its noteworthy liabilities, Franklin Electric boasts net cash, so it's fair to say it does not have a heavy debt load!
But the other side of the story is that Franklin Electric saw its EBIT decline by 5.0% over the last year. If earnings continue to decline at that rate the company may have increasing difficulty managing its debt load. There's no doubt that we learn most about debt from the balance sheet. But it is future earnings, more than anything, that will determine Franklin Electric'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.
But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. While Franklin Electric has net cash on its balance sheet, it's still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. Happily for any shareholders, Franklin Electric actually produced more free cash flow than EBIT over the last three years. That sort of strong cash generation warms our hearts like a puppy in a bumblebee suit.
We could understand if investors are concerned about Franklin Electric's liabilities, but we can be reassured by the fact it has has net cash of US$20.2m. And it impressed us with free cash flow of US$200m, being 103% of its EBIT. So is Franklin Electric's debt a risk? It doesn't seem so to us. We'd be motivated to research the stock further if we found out that Franklin Electric insiders have bought shares recently. If you would too, then you're in luck, since today we're sharing our list of reported insider transactions for free.
At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.
This article by Simply Wall St is general in nature. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.
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