Is Bega Cheese (ASX:BGA) A Risky Investment?

Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. Importantly, Bega Cheese Limited (ASX:BGA) does carry debt. But the more important question is: how much risk is that debt creating?

When Is Debt A Problem?

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. If things get really bad, the lenders can take control of the business. 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 step when considering a company's debt levels is to consider its cash and debt together.

Check out our latest analysis for Bega Cheese

How Much Debt Does Bega Cheese Carry?

The image below, which you can click on for greater detail, shows that Bega Cheese had debt of AU$98.6m at the end of December 2020, a reduction from AU$324.4m over a year. But it also has AU$251.2m in cash to offset that, meaning it has AU$152.6m net cash.

How Healthy Is Bega Cheese's Balance Sheet?

According to the last reported balance sheet, Bega Cheese had liabilities of AU$286.0m due within 12 months, and liabilities of AU$153.6m due beyond 12 months. Offsetting these obligations, it had cash of AU$251.2m as well as receivables valued at AU$114.9m due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by AU$73.5m.

Given Bega Cheese has a market capitalization of AU$1.81b, 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. While it does have liabilities worth noting, Bega Cheese also has more cash than debt, so we're pretty confident it can manage its debt safely.

On top of that, Bega Cheese grew its EBIT by 60% over the last twelve months, and that growth will make it easier to handle its debt. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately the future profitability of the business will decide if Bega Cheese can strengthen its balance sheet over time. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. While Bega Cheese 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. Over the last three years, Bega Cheese recorded free cash flow worth a fulsome 93% of its EBIT, which is stronger than we'd usually expect. That puts it in a very strong position to pay down debt.

Summing up

While it is always sensible to look at a company's total liabilities, it is very reassuring that Bega Cheese has AU$152.6m in net cash. And it impressed us with free cash flow of AU$70m, being 93% of its EBIT. So is Bega Cheese's debt a risk? It doesn't seem so to us. 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. We've identified 1 warning sign with Bega Cheese , and understanding them should be part of your investment process.

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.

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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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