Would Farm Pride Foods (ASX:FRM) Be Better Off With Less Debt?

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. We note that Farm Pride Foods Limited (ASX:FRM) does have debt on its balance sheet. But is this debt a concern to shareholders?

We've discovered 3 warning signs about Farm Pride Foods. View them for free.

What Risk Does Debt Bring?

Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. 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. The first step when considering a company's debt levels is to consider its cash and debt together.

What Is Farm Pride Foods's Net Debt?

As you can see below, Farm Pride Foods had AU$13.4m of debt at December 2024, down from AU$18.3m a year prior. However, it also had AU$4.84m in cash, and so its net debt is AU$8.61m.

A Look At Farm Pride Foods' Liabilities

According to the last reported balance sheet, Farm Pride Foods had liabilities of AU$28.8m due within 12 months, and liabilities of AU$22.8m due beyond 12 months. Offsetting this, it had AU$4.84m in cash and AU$7.98m in receivables that were due within 12 months. So its liabilities total AU$38.7m more than the combination of its cash and short-term receivables.

This deficit is considerable relative to its market capitalization of AU$50.8m, so it does suggest shareholders should keep an eye on Farm Pride Foods' use of debt. This suggests shareholders would be heavily diluted if the company needed to shore up its balance sheet in a hurry. 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 if you're keen to discover more about its earnings, it might be worth checking out this graph of its long term earnings trend.

View our latest analysis for Farm Pride Foods

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

Over the last twelve months Farm Pride Foods produced an earnings before interest and tax (EBIT) loss. Indeed, it lost AU$3.2m at the EBIT level. Considering that alongside the liabilities mentioned above does not give us much confidence that company should be using so much debt. So we think its balance sheet is a little strained, though not beyond repair. On the bright side, we note that trailing twelve month EBIT is worse than the free cash flow of AU$4.0m and the profit of AU$206k. So if we focus on those metrics there seems to be a chance the company will manage its debt without much trouble. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. Be aware that Farm Pride Foods is showing 3 warning signs in our investment analysis , and 1 of those is a bit unpleasant...

At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.

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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.