Is Bega Cheese (ASX:BGA) Using Too Much Debt?

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 can see that Bega Cheese Limited (ASX:BGA) does use debt in its business. But is this debt a concern to shareholders?

When Is Debt Dangerous?

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. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

View our latest analysis for Bega Cheese

How Much Debt Does Bega Cheese Carry?

You can click the graphic below for the historical numbers, but it shows that Bega Cheese had AU$226.7m of debt in June 2024, down from AU$269.0m, one year before. However, it also had AU$65.6m in cash, and so its net debt is AU$161.1m.

How Strong Is Bega Cheese's Balance Sheet?

The latest balance sheet data shows that Bega Cheese had liabilities of AU$707.5m due within a year, and liabilities of AU$416.5m falling due after that. Offsetting this, it had AU$65.6m in cash and AU$365.7m in receivables that were due within 12 months. So its liabilities total AU$692.7m more than the combination of its cash and short-term receivables.

While this might seem like a lot, it is not so bad since Bega Cheese has a market capitalization of AU$1.75b, and so it could probably strengthen its balance sheet by raising capital if it needed to. But it's clear that we should definitely closely examine whether it can manage its debt without dilution.

We measure a company's debt load relative to its earnings power by looking at its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and by calculating how easily its earnings before interest and tax (EBIT) cover its interest expense (interest cover). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

While Bega Cheese has a quite reasonable net debt to EBITDA multiple of 1.6, its interest cover seems weak, at 1.7. This does suggest the company is paying fairly high interest rates. Either way there's no doubt the stock is using meaningful leverage. Pleasingly, Bega Cheese is growing its EBIT faster than former Australian PM Bob Hawke downs a yard glass, boasting a 256% gain in the last twelve months. 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 want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So we always check how much of that EBIT is translated into free cash flow. During the last three years, Bega Cheese produced sturdy free cash flow equating to 62% of its EBIT, about what we'd expect. This cold hard cash means it can reduce its debt when it wants to.

Our View

On our analysis Bega Cheese's EBIT growth rate should signal that it won't have too much trouble with its debt. However, our other observations weren't so heartening. To be specific, it seems about as good at covering its interest expense with its EBIT as wet socks are at keeping your feet warm. When we consider all the elements mentioned above, it seems to us that Bega Cheese is managing its debt quite well. Having said that, the load is sufficiently heavy that we would recommend any shareholders keep a close eye on it. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. Be aware that Bega Cheese is showing 1 warning sign in our investment analysis , you should know about...

At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.

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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.