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 seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. Importantly, Forum Energy Technologies, Inc. (NYSE:FET) does carry debt. But the real question is whether this debt is making the company risky.
What Risk Does Debt Bring?
Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. 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. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.
What Is Forum Energy Technologies's Net Debt?
As you can see below, at the end of June 2022, Forum Energy Technologies had US$268.8m of debt, up from US$231.7m a year ago. Click the image for more detail. On the flip side, it has US$26.9m in cash leading to net debt of about US$241.9m.
A Look At Forum Energy Technologies' Liabilities
We can see from the most recent balance sheet that Forum Energy Technologies had liabilities of US$184.3m falling due within a year, and liabilities of US$314.7m due beyond that. On the other hand, it had cash of US$26.9m and US$163.3m worth of receivables due within a year. So it has liabilities totalling US$308.9m more than its cash and near-term receivables, combined.
This deficit casts a shadow over the US$153.4m company, like a colossus towering over mere mortals. So we definitely think shareholders need to watch this one closely. At the end of the day, Forum Energy Technologies would probably need a major re-capitalization if its creditors were to demand repayment. The balance sheet is clearly the area to focus on when you are analysing debt. But it is Forum Energy Technologies's earnings that will influence how the balance sheet holds up in the future. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.
Over 12 months, Forum Energy Technologies reported revenue of US$617m, which is a gain of 32%, although it did not report any earnings before interest and tax. Shareholders probably have their fingers crossed that it can grow its way to profits.
Caveat Emptor
While we can certainly appreciate Forum Energy Technologies's revenue growth, its earnings before interest and tax (EBIT) loss is not ideal. Indeed, it lost a very considerable US$21m at the EBIT level. When we look at that alongside the significant liabilities, we're not particularly confident about the company. It would need to improve its operations quickly for us to be interested in it. Not least because it burned through US$74m in negative free cash flow over the last year. That means it's on the risky side of things. 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. We've identified 1 warning sign with Forum Energy Technologies , and understanding them should be part of your investment process.
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.
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