Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a 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 Foley Family Wines Limited (NZSE:FWL) makes use of debt. But is this debt a concern to shareholders?
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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. When we examine debt levels, we first consider both cash and debt levels, together.
How Much Debt Does Foley Family Wines Carry?
The image below, which you can click on for greater detail, shows that Foley Family Wines had debt of NZ$19.4m at the end of December 2018, a reduction from NZ$20.4m over a year. But it also has NZ$24.6m in cash to offset that, meaning it has NZ$5.15m net cash.
How Strong Is Foley Family Wines's Balance Sheet?
The latest balance sheet data shows that Foley Family Wines had liabilities of NZ$14.4m due within a year, and liabilities of NZ$19.4m falling due after that. Offsetting this, it had NZ$24.6m in cash and NZ$8.27m in receivables that were due within 12 months. So it has liabilities totalling NZ$968.0k more than its cash and near-term receivables, combined.
Having regard to Foley Family Wines's size, it seems that its liquid assets are well balanced with its total liabilities. So it's very unlikely that the NZ$124.9m company is short on cash, but still worth keeping an eye on the balance sheet. Despite its noteworthy liabilities, Foley Family Wines boasts net cash, so it's fair to say it does not have a heavy debt load!
On the other hand, Foley Family Wines's EBIT dived 19%, over the last year. If that rate of decline in earnings continues, the company could find itself in a tight spot. The balance sheet is clearly the area to focus on when you are analysing debt. But you can't view debt in total isolation; since Foley Family Wines will need earnings to service that debt. So if you're keen to discover more about its earnings, it might be worth checking out this graph of its long term earnings trend.
Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. While Foley Family Wines 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. Looking at the most recent three years, Foley Family Wines recorded free cash flow of 24% of its EBIT, which is weaker than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.
We could understand if investors are concerned about Foley Family Wines's liabilities, but we can be reassured by the fact it has has net cash of NZ$5.2m. So while Foley Family Wines does not have a great balance sheet, it's certainly not too bad. Above most other metrics, we think its important to track how fast earnings per share is growing, if at all. If you've also come to that realization, you're in luck, because today you can view this interactive graph of Foley Family Wines's earnings per share history for free.
If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.
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If you spot an error that warrants correction, please contact the editor at email@example.com. 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. Simply Wall St has no position in the stocks mentioned. Thank you for reading.