Is Freenet (ETR: FNTN) a risky investment?

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David Iben put it well when he said, “Volatility is not a risk we care about. What matters to us is to avoid the 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. We can see that freenet SA (ETR: FNTN) uses debt in its activities. But should shareholders be concerned about its use of debt?

When Is Debt a Problem?

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. In the worst case scenario, a business can go bankrupt if it cannot pay its creditors. While it’s not too common, we often see indebted companies continually diluting their shareholders because lenders are forcing them to raise capital at a ridiculous price. That said, the most common situation is where a business manages its debt reasonably well – and to its own advantage. When we look at debt levels, we first consider both cash and debt levels.

Check out our latest review for freenet

What is freenet’s net debt?

As you can see below, freenet had € 739.9 million in debt in March 2021, up from € 1.73 billion the year before. However, because it has a cash reserve of € 554.2 million, its net debt is lower, at around € 185.7 million.

XTRA: FNTN History of debt to equity July 7, 2021

A look at freenet’s responsibilities

The latest balance sheet data shows that freenet had debts of 1.02 billion euros due within one year, and debts of 1.39 billion euros due thereafter. In return, it had € 554.2 million in cash and € 359.3 million in receivables due within 12 months. Its liabilities thus exceed the sum of its cash and its (short-term) receivables by 1.50 billion euros.

This deficit is sizable compared to its market capitalization of 2.46 billion euros, so he suggests shareholders keep an eye on Freenet’s use of debt. This suggests that shareholders would be heavily diluted if the company needed to consolidate its balance sheet quickly.

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.

Looking at its net debt over EBITDA of 0.61 and interest coverage of 7.0 times, it seems to us that freenet is probably using the debt in a fairly reasonable way. But the interest payments are certainly enough to make us think about how affordable his debt is. Freenet’s EBIT has been fairly stable over the past year, but that shouldn’t be a problem considering it doesn’t have a lot of debt. The balance sheet is clearly the area you need to focus on when analyzing debt. But ultimately, the company’s future profitability will decide whether freenet 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.

But our last consideration is also important, because a company cannot pay its debts with paper profits; he needs hard cash. We therefore always check how much of this EBIT is converted into free cash flow. Fortunately for all shareholders, freenet has actually generated more free cash flow than EBIT over the past three years. This kind of strong cash generation warms our hearts like a puppy in a bumblebee costume.

Our point of view

The good news is that freenet’s proven ability to convert EBIT into free cash flow delights us like a fluffy puppy does a toddler. But frankly, we think his total passive level undermines that feeling a bit. All these things considered, it looks like freenet can comfortably manage its current debt levels. Of course, while this leverage can improve returns on equity, it brings more risk, so it’s worth keeping an eye out for. There is no doubt that we learn the most about debt from the balance sheet. However, not all investment risks lie on the balance sheet – far from it. To do this, you need to know the 2 warning signs we spotted with freenet.

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.

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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.
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