Is Farm Pride Foods (ASX:FRM) A Risky Investment?

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.' So it seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. We can see that Farm Pride Foods Limited (ASX:FRM) does use debt in its business. But should shareholders be worried about its use of debt?

When Is Debt A Problem?

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. 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, 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. When we examine debt levels, we first consider both cash and debt levels, together.

Check out our latest analysis for Farm Pride Foods

How Much Debt Does Farm Pride Foods Carry?

You can click the graphic below for the historical numbers, but it shows that as of December 2020 Farm Pride Foods had AU$19.5m of debt, an increase on AU$17.3m, over one year. On the flip side, it has AU$2.07m in cash leading to net debt of about AU$17.5m.

How Strong Is Farm Pride Foods' Balance Sheet?

According to the last reported balance sheet, Farm Pride Foods had liabilities of AU$15.5m due within 12 months, and liabilities of AU$29.4m due beyond 12 months. On the other hand, it had cash of AU$2.07m and AU$6.61m worth of receivables due within a year. So its liabilities total AU$36.3m more than the combination of its cash and short-term receivables.

This deficit casts a shadow over the AU$21.5m company, like a colossus towering over mere mortals. So we'd watch its balance sheet closely, without a doubt. At the end of the day, Farm Pride Foods would probably need a major re-capitalization if its creditors were to demand repayment. The balance sheet is clearly the area to focus on when you are analysing debt. But you can't view debt in total isolation; since Farm Pride Foods 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, Farm Pride Foods saw its revenue hold pretty steady, and it did not report positive earnings before interest and tax. While that hardly impresses, its not too bad either.

Caveat Emptor

Importantly, Farm Pride Foods had an earnings before interest and tax (EBIT) loss over the last year. Indeed, it lost AU$270k at the EBIT level. Considering that alongside the liabilities mentioned above make us nervous about the company. We'd want to see some strong near-term improvements before getting too interested in the stock. For example, we would not want to see a repeat of last year's loss of AU$6.5m. And until that time we think this is a risky stock. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. These risks can be hard to spot. Every company has them, and we've spotted 4 warning signs for Farm Pride Foods (of which 2 are potentially serious!) you should know about.

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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