Here's Why Duxton Broadacre Farms (ASX:DBF) Can Afford Some Debt

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.' 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. As with many other companies Duxton Broadacre Farms Limited (ASX:DBF) makes use of debt. But the more important question is: how much risk is that debt creating?

What Risk Does Debt Bring?

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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. Of course, plenty of companies use debt to fund growth, without any negative consequences. When we examine debt levels, we first consider both cash and debt levels, together.

Check out our latest analysis for Duxton Broadacre Farms

What Is Duxton Broadacre Farms's Debt?

You can click the graphic below for the historical numbers, but it shows that as of June 2020 Duxton Broadacre Farms had AU$31.5m of debt, an increase on AU$26.7m, over one year. Net debt is about the same, since the it doesn't have much cash.

How Healthy Is Duxton Broadacre Farms's Balance Sheet?

According to the last reported balance sheet, Duxton Broadacre Farms had liabilities of AU$8.10m due within 12 months, and liabilities of AU$27.7m due beyond 12 months. Offsetting this, it had AU$27.0k in cash and AU$547.0k in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by AU$35.2m.

This is a mountain of leverage relative to its market capitalization of AU$58.3m. Should its lenders demand that it shore up the balance sheet, shareholders would likely face severe dilution. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since Duxton Broadacre Farms will need earnings to service that debt. 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 Duxton Broadacre Farms had a loss before interest and tax, and actually shrunk its revenue by 7.3%, to AU$13m. We would much prefer see growth.

Caveat Emptor

Importantly, Duxton Broadacre Farms had an earnings before interest and tax (EBIT) loss over the last year. Indeed, it lost AU$2.9m at the EBIT level. Considering that alongside the liabilities mentioned above does not give us much confidence that company should be using so much debt. So we think its balance sheet is a little strained, though not beyond repair. However, it doesn't help that it burned through AU$4.8m of cash over the last year. So in short it's a really risky stock. 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 4 warning signs we've spotted with Duxton Broadacre Farms (including 2 which is make us uncomfortable) .

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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