Is the FNM (BIT: FNM) a risky investment?
Legendary fund manager Li Lu (who Charlie Munger supported) once said, “The biggest risk in investing is not price volatility, but the possibility that you will suffer a permanent loss of capital. When we think about how risky a business is, we always like to look at its use of debt because debt overload can lead to bankruptcy. Like many other companies FNM SpA (BIT: FNM) uses debt. But should shareholders be concerned about its use of debt?
Why Does Debt Bring Risk?
Debt helps a business until the business struggles to repay it, either with new capital or with free cash flow. Ultimately, if the company cannot meet its legal debt repayment obligations, shareholders could walk away with nothing. However, a more common (but still costly) situation is where a company has to dilute its shareholders at a cheap share price just to get its debt under control. Of course, debt can be an important tool in businesses, especially capital intensive businesses. The first step in examining a company’s debt levels is to consider its cash flow and debt together.
See our latest analysis for FNM
What is FNM’s net debt?
You can click on the graph below for the historical figures, but it shows that as of June 2021, the FNM had 1.08 billion euros in debt, an increase from 394.0 million euros, over a year. On the other hand, it has 385.5 million euros in cash, leading to a net debt of around 696.0 million euros.
How strong is FNM’s balance sheet?
The most recent balance sheet shows that FNM had liabilities of 1.25 billion euros due within one year and liabilities of 389.1 million euros due beyond. In return, he had € 385.5 million in cash and € 225.9 million in receivables due within 12 months. It therefore has total liabilities of 1.03 billion euros more than its combined cash and short-term receivables.
This deficit casts a shadow over the € 277.0 million company, like a colossus dominating mere mortals. So we would be watching its record closely, without a doubt. Ultimately, FNM would likely need a major recapitalization if its creditors demanded repayment.
We use two main ratios to inform us about the levels of debt compared to earnings. The first is net debt divided by earnings before interest, taxes, depreciation, and amortization (EBITDA), while the second is the number of times its profit before interest and taxes (EBIT) covers its interest expense (or its coverage of interest, for short). In this way, we consider both the absolute amount of debt, as well as the interest rates paid on it.
FNM has a fairly high debt-to-EBITDA ratio of 7.4, which suggests significant leverage. But the good news is that he enjoys a pretty heartwarming 3.8 times interest coverage, which suggests he can meet his obligations responsibly. The good news is that FNM has increased its EBIT by 82% over the past twelve months. Like a mother’s loving embrace of a newborn, this type of growth builds resilience, putting the business in a stronger position to manage debt. When analyzing debt levels, the balance sheet is the obvious starting point. But ultimately, the company’s future profitability will decide whether FNM can strengthen its balance sheet over time. So, if you want to see what the professionals think, you might find this free analyst earnings forecast report interesting.
Finally, a business needs free cash flow to repay its debts; accounting profits are not enough. The logical step is therefore to examine the proportion of this EBIT that corresponds to the actual free cash flow. Over the past three years, FNM has recorded free cash flow of 38% of its EBIT, which is lower than expected. It’s not great when it comes to paying down debt.
Our point of view
To be frank, FNM’s net debt to EBITDA and its history of staying above its total liabilities makes us rather uncomfortable with its debt levels. But on the positive side, its EBIT growth rate is a good sign and makes us more optimistic. Overall, we think it’s fair to say that FNM has enough debt that there is real risk around the balance sheet. If all goes well it may pay off, but the downside to this debt is a greater risk of permanent losses. When analyzing debt levels, the balance sheet is the obvious starting point. However, not all investment risks lie on the balance sheet – far from it. For example, we discovered 2 warning signs for FNM (1 shouldn’t be ignored!) Which you should be aware of before investing here.
Of course, if you are the type of investor who prefers to buy stocks without going into debt, feel free to check out our exclusive list of cash net 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 using only unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell shares and does not take into account your goals or your financial situation. Our aim is to bring you long-term, targeted analysis based on fundamental data. Note that our analysis may not take into account the latest announcements from price sensitive companies or qualitative documents. Simply Wall St has no position in the mentioned stocks.
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