Is Ferrexpo (LON:FXPO) Using Too Much Debt?

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 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. We can see that Ferrexpo plc (LON:FXPO) does use debt in its business. But the real question is whether this debt is making the company risky.

When Is Debt Dangerous?

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 frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. Of course, plenty of companies use debt to fund growth, without any negative consequences. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

Check out our latest analysis for Ferrexpo

What Is Ferrexpo's Debt?

The image below, which you can click on for greater detail, shows that Ferrexpo had debt of US$15.3m at the end of June 2021, a reduction from US$334.8m over a year. However, its balance sheet shows it holds US$234.7m in cash, so it actually has US$219.3m net cash.

debt-equity-history-analysisdebt-equity-history-analysis
debt-equity-history-analysis

A Look At Ferrexpo's Liabilities

The latest balance sheet data shows that Ferrexpo had liabilities of US$281.5m due within a year, and liabilities of US$39.4m falling due after that. On the other hand, it had cash of US$234.7m and US$249.7m worth of receivables due within a year. So it can boast US$163.4m more liquid assets than total liabilities.

This surplus suggests that Ferrexpo has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Simply put, the fact that Ferrexpo has more cash than debt is arguably a good indication that it can manage its debt safely.

Even more impressive was the fact that Ferrexpo grew its EBIT by 177% over twelve months. That boost will make it even easier to pay down debt going forward. The balance sheet is clearly the area to focus on when you are analysing debt. But it is future earnings, more than anything, that will determine Ferrexpo'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 Ferrexpo 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. During the last three years, Ferrexpo produced sturdy free cash flow equating to 56% of its EBIT, about what we'd expect. This cold hard cash means it can reduce its debt when it wants to.

Summing up

While it is always sensible to investigate a company's debt, in this case Ferrexpo has US$219.3m in net cash and a decent-looking balance sheet. And it impressed us with its EBIT growth of 177% over the last year. So we don't think Ferrexpo's use of debt is risky. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet – far from it. For instance, we've identified 3 warning signs for Ferrexpo (1 doesn't sit too well with us) you should be aware of.

When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.

This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. 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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

By Matt Earle

Matthew Earle is the Founder of MiningFeeds. In 2005, Matt founded MiningNerds.com to provide data and information to the mining investment community. This site was merged with Highgrade Review to form MiningFeeds. Matt has a B.Sc. degree with a minor in geology from the University of Toronto.

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