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

Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' 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. We note that Farm Pride Foods Limited (ASX:FRM) does have debt on its balance sheet. But should shareholders be worried about its use of debt?

What Risk Does Debt Bring?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth 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

What Is Farm Pride Foods's Net Debt?

As you can see below, at the end of June 2023, Farm Pride Foods had AU$15.8m of debt, up from AU$11.6m a year ago. Click the image for more detail. On the flip side, it has AU$1.99m in cash leading to net debt of about AU$13.8m.

A Look At Farm Pride Foods' Liabilities

The latest balance sheet data shows that Farm Pride Foods had liabilities of AU$19.7m due within a year, and liabilities of AU$31.2m falling due after that. On the other hand, it had cash of AU$1.99m and AU$8.62m worth of receivables due within a year. So its liabilities total AU$40.3m more than the combination of its cash and short-term receivables.

This deficit casts a shadow over the AU$18.7m company, like a colossus towering over mere mortals. So we'd watch its balance sheet closely, without a doubt. After all, Farm Pride Foods would likely require a major re-capitalisation if it had to pay its creditors today. 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 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$83m, which is a gain of 12%, 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

Over the last twelve months Farm Pride Foods produced an earnings before interest and tax (EBIT) loss. Its EBIT loss was a whopping AU$6.5m. 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. Not least because it had negative free cash flow of AU$3.9m over the last twelve months. That means it's on the risky side of things. 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. For example, we've discovered 4 warning signs for Farm Pride Foods (3 make us uncomfortable!) that you should be aware of before investing here.

When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.

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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.