Is Farm Pride Foods (ASX:FRM) Using Debt Sensibly?

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 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 the more important question is: how much risk is that debt creating?

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. If things get really bad, the lenders can take control of the business. 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.

See 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 2020, Farm Pride Foods had AU$19.5m of debt, up from AU$17.3m a year ago. Click the image for more detail. On the flip side, it has AU$2.07m in cash leading to net debt of about AU$17.5m.

How Healthy Is Farm Pride Foods' Balance Sheet?

We can see from the most recent balance sheet that Farm Pride Foods had liabilities of AU$15.5m falling due within a year, and liabilities of AU$29.4m due beyond that. Offsetting these obligations, it had cash of AU$2.07m as well as receivables valued at AU$6.61m due within 12 months. 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$14.3m 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. When analysing debt levels, the balance sheet is the obvious place to start. But it is Farm Pride Foods's earnings that will influence how the balance sheet holds up in the future. 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.

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's not too bad, we'd prefer see growth.

Caveat Emptor

Importantly, Farm Pride Foods had an earnings before interest and tax (EBIT) loss over the last year. Indeed, it lost AU$268k at the EBIT level. If you consider the significant liabilities mentioned above, we are extremely wary of this investment. That said, it is possible that the company will turn its fortunes around. Nevertheless, we would not bet on it given that it lost AU$6.5m in just last twelve months, and it doesn't have much by way of liquid assets. So while it's not wise to assume the company will fail, we do think it's risky. 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. 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 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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