Warren Buffett famously said, 'Volatility is far from synonymous with risk.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. We note that Frequency Electronics, Inc. (NASDAQ:FEIM) does have debt on its balance sheet. But the more important question is: how much risk is that debt creating?
Why Does Debt Bring Risk?
Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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. Of course, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. The first step when considering a company's debt levels is to consider its cash and debt together.
What Is Frequency Electronics's Net Debt?
The image below, which you can click on for greater detail, shows that at April 2020 Frequency Electronics had debt of US$4.97m, up from none in one year. But it also has US$14.4m in cash to offset that, meaning it has US$9.41m net cash.
How Strong Is Frequency Electronics's Balance Sheet?
We can see from the most recent balance sheet that Frequency Electronics had liabilities of US$13.0m falling due within a year, and liabilities of US$24.1m due beyond that. Offsetting this, it had US$14.4m in cash and US$11.3m in receivables that were due within 12 months. So it has liabilities totalling US$11.3m more than its cash and near-term receivables, combined.
Given Frequency Electronics has a market capitalization of US$91.6m, it's hard to believe these liabilities pose much threat. But there are sufficient liabilities that we would certainly recommend shareholders continue to monitor the balance sheet, going forward. Despite its noteworthy liabilities, Frequency Electronics boasts net cash, so it's fair to say it does not have a heavy debt load! The balance sheet is clearly the area to focus on when you are analysing debt. But it is Frequency Electronics's earnings that will influence how the balance sheet holds up in the future. 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.
In the last year Frequency Electronics had a loss before interest and tax, and actually shrunk its revenue by 16%, to US$42m. That's not what we would hope to see.
So How Risky Is Frequency Electronics?
We have no doubt that loss making companies are, in general, riskier than profitable ones. And in the last year Frequency Electronics had an earnings before interest and tax (EBIT) loss, truth be told. And over the same period it saw negative free cash outflow of US$2.9m and booked a US$10.0m accounting loss. While this does make the company a bit risky, it's important to remember it has net cash of US$9.41m. That means it could keep spending at its current rate for more than two years. Overall, we'd say the stock is a bit risky, and we're usually very cautious until we see positive free cash flow. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. To that end, you should learn about the 2 warning signs we've spotted with Frequency Electronics (including 1 which is is potentially serious) .
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.
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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