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

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 Farm Pride Foods Limited (ASX:FRM) makes use of debt. But the real question is whether this debt is making the company risky.

When Is Debt A Problem?

Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. If things get really bad, the lenders can take control of the business. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. 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?

As you can see below, at the end of December 2022, Farm Pride Foods had AU$17.7m of debt, up from AU$11.3m a year ago. Click the image for more detail. On the flip side, it has AU$1.69m in cash leading to net debt of about AU$16.0m.

How Healthy Is Farm Pride Foods' Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Farm Pride Foods had liabilities of AU$25.8m due within 12 months and liabilities of AU$31.0m due beyond that. On the other hand, it had cash of AU$1.69m and AU$10.0m worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by AU$45.1m.

This deficit casts a shadow over the AU$19.4m company, like a colossus towering over mere mortals. So we definitely think shareholders need to watch this one closely. After all, Farm Pride Foods would likely require a major re-capitalisation if it had to pay its creditors today. There's no doubt that we learn most about debt from the balance sheet. But it is Farm Pride Foods's earnings that will influence how the balance sheet holds up in the future. 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 reported revenue of AU$74m, which is a gain of 2.0%, 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, Farm Pride Foods had an earnings before interest and tax (EBIT) loss over the last year. Indeed, it lost a very considerable AU$13m at the EBIT level. When we look at that alongside the significant liabilities, we're not particularly confident about the company. We'd want to see some strong near-term improvements before getting too interested in the stock. Not least because it burned through AU$5.1m in negative free cash flow over the last year. So suffice it to say we consider the stock to be risky. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. We've identified 5 warning signs with Farm Pride Foods (at least 4 which are potentially serious) , and understanding them should be part of your investment process.

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

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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.