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

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.' 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. 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. 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 think about a company's use of debt, we first look at cash and debt together.

View our latest analysis for Farm Pride Foods

How Much Debt Does Farm Pride Foods Carry?

The image below, which you can click on for greater detail, shows that at June 2023 Farm Pride Foods had debt of AU$15.8m, up from AU$11.6m in one year. 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

Zooming in on the latest balance sheet data, we can see that Farm Pride Foods had liabilities of AU$19.7m due within 12 months and liabilities of AU$31.2m due beyond that. Offsetting these obligations, it had cash of AU$1.99m as well as receivables valued at AU$8.62m due within 12 months. So its liabilities total AU$40.3m more than the combination of its cash and short-term receivables.

The deficiency here weighs heavily on the AU$23.7m company itself, as if a child were struggling under the weight of an enormous back-pack full of books, his sports gear, and a trumpet. 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 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. We usually like to see faster growth from unprofitable companies, but each to their own.

Caveat Emptor

Over the last twelve months Farm Pride Foods produced an earnings before interest and tax (EBIT) loss. Indeed, it lost a very considerable AU$6.5m at the EBIT level. Considering that alongside the liabilities mentioned above make us nervous about the company. It would need to improve its operations quickly for us to be interested in it. Not least because it burned through AU$3.9m in negative free cash flow over the last year. That means it's on the risky side of things. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. To that end, you should learn about the 4 warning signs we've spotted with Farm Pride Foods (including 3 which are potentially serious) .

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.