Howard Marks put it well when he said that, rather than worrying about stock price volatility, “The possibility of permanent loss is the risk that worries me … and every investor practices that I know is worried “. So it can be obvious that you need to consider debt, when you think about how risky a given stock is because too much debt can sink a business. We can see that Fomento de Construcciones y Contratas, SA (BME: FCC) uses debt in its business. But should shareholders be worried about its use of debt?
Why Does Debt Bring Risk?
Debts and other liabilities become risky for a business when it cannot easily meet these obligations, either with free cash flow or by raising capital at an attractive price. An integral part of capitalism is the process of “creative destruction” where bankrupt companies are ruthlessly liquidated by their bankers. However, a more common (but still costly) event is when a company has to issue stock at bargain prices, constantly diluting shareholders, just to strengthen its balance sheet. That said, the most common situation is where a business manages its debt reasonably well – and to its own advantage. The first step in examining a company’s debt levels is to consider its cash flow and debt together.
Check out our latest review for Fomento de Construcciones y Contratas
What is the net debt of Fomento de Construcciones y Contratas?
As you can see below, Fomento de Construcciones y Contratas had a debt of 4.15 billion euros in March 2021, compared to 5.06 billion euros the previous year. On the other hand, it has 1.53 billion euros in liquidity leading to a net debt of around 2.61 billion euros.
What is the balance sheet of Fomento de Construcciones y Contratas?
According to the latest published balance sheet, Fomento de Construcciones y Contratas had liabilities of 3.11 billion euros within 12 months and liabilities of 5.57 billion euros due beyond 12 months. In compensation for these obligations, he had cash of € 1.53 billion as well as receivables valued at € 2.20 billion within 12 months. Its liabilities therefore amount to € 4.95 billion more than the combination of its cash and short-term receivables.
When you consider that this deficit exceeds the company’s € 4.30 billion market capitalization, you may well be inclined to carefully review the balance sheet. Hypothetically, extremely high dilution would be required if the company was forced to repay its debts by raising capital at the current share price.
In order to measure a company’s debt relative to its profits, we calculate its net debt divided by its earnings before interest, taxes, depreciation and amortization (EBITDA) and its profit before interest and taxes (EBIT) divided by its interest. debtors (its interest coverage). In this way, we consider both the absolute amount of debt, as well as the interest rates paid on it.
Fomento de Construcciones y Contratas has a debt / EBITDA ratio of 2.5 and its EBIT covered its interest charges 5.4 times. This suggests that while debt levels are significant, we would stop calling them problematic. If Fomento de Construcciones y Contratas can continue to increase its EBIT at the rate of 11% last year compared to last year, then it will find its debt more manageable. When analyzing debt levels, the balance sheet is the obvious starting point. But ultimately, the company’s future profitability will decide whether Fomento de Construcciones y Contratas 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, while the tax authorities love accounting profits, lenders only accept hard cash. We therefore always check how much of this EBIT is converted into free cash flow. Over the past three years, Fomento de Construcciones y Contratas has recorded free cash flow of 45% of its EBIT, which is lower than expected. It’s not great when it comes to paying down debt.
Our point of view
Fomento de Construcciones y Contratas’ struggle to manage its total liabilities made us doubt the strength of its balance sheet, but the other data points we considered were relatively interesting. For example, its EBIT growth rate is relatively strong. Taking the above factors together, we believe that the debt of Fomento de Construcciones y Contratas presents certain risks to the business. While this debt may increase returns, we believe the company now has sufficient leverage. When analyzing debt levels, the balance sheet is the obvious starting point. But at the end of the day, every business can contain risks that exist off the balance sheet. To this end, you should inquire about the 3 warning signs we spotted with Fomento de Construcciones y Contratas (including 1 that cannot be ignored).
If you are interested in investing in companies that can generate profits without the burden of debt, check out this page. free list of growing companies that have net cash on the balance sheet.
If you decide to trade Fomento de Construcciones y Contratas, use the cheapest platform * which is ranked # 1 overall by Barron’s, Interactive brokers. Trade stocks, options, futures, currencies, bonds and funds in 135 markets, all from one integrated account.
This Simply Wall St article is general in nature. 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 material. Simply Wall St has no position in any of the stocks mentioned.
*Interactive Brokers Ranked Least Expensive Broker By StockBrokers.com Online Annual Review 2020
Do you have any feedback on this item? Are you worried about the content? Get in touch with us directly. You can also send an email to the editorial team (at) simplywallst.com.