Is Food Revolution Group (ASX:FOD) Using Debt In A Risky Way?

The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. As with many other companies The Food Revolution Group Limited (ASX:FOD) makes use of debt. But the real question is whether this debt is making the company risky.

Why Does Debt Bring Risk?

Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. 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. Of course, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest 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.

Check out our latest analysis for Food Revolution Group

What Is Food Revolution Group's Net Debt?

As you can see below, Food Revolution Group had AU$7.58m of debt, at June 2020, which is about the same as the year before. You can click the chart for greater detail. On the flip side, it has AU$2.94m in cash leading to net debt of about AU$4.65m.

How Healthy Is Food Revolution Group's Balance Sheet?

According to the last reported balance sheet, Food Revolution Group had liabilities of AU$20.4m due within 12 months, and liabilities of AU$11.7m due beyond 12 months. Offsetting this, it had AU$2.94m in cash and AU$1.96m in receivables that were due within 12 months. So it has liabilities totalling AU$27.3m more than its cash and near-term receivables, combined.

This is a mountain of leverage relative to its market capitalization of AU$27.8m. Should its lenders demand that it shore up the balance sheet, shareholders would likely face severe dilution. There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since Food Revolution Group will need earnings to service that debt. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

Over 12 months, Food Revolution Group reported revenue of AU$35m, which is a gain of 19%, although it did not report any earnings before interest and tax. That rate of growth is a bit slow for our taste, but it takes all types to make a world.

Caveat Emptor

Importantly, Food Revolution Group had an earnings before interest and tax (EBIT) loss over the last year. Indeed, it lost a very considerable AU$8.7m 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. Another cause for caution is that is bled AU$4.7m in negative free cash flow over the last twelve months. So in short it's a really risky stock. 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. Like risks, for instance. Every company has them, and we've spotted 5 warning signs for Food Revolution Group (of which 2 don't sit too well with us!) you should know about.

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

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