Health Check: How Prudently Does Halo Food (ASX:HLF) Use Debt?

Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk.' 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 can see that Halo Food Co. Limited (ASX:HLF) does use debt in its business. But the real question is whether this debt is making the company risky.

Why Does Debt Bring Risk?

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. 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.

Our analysis indicates that HLF is potentially overvalued!

What Is Halo Food's Debt?

You can click the graphic below for the historical numbers, but it shows that as of September 2022 Halo Food had AU$15.7m of debt, an increase on AU$5.33m, over one year. However, it also had AU$3.48m in cash, and so its net debt is AU$12.2m.

How Healthy Is Halo Food's Balance Sheet?

We can see from the most recent balance sheet that Halo Food had liabilities of AU$26.7m falling due within a year, and liabilities of AU$23.8m due beyond that. On the other hand, it had cash of AU$3.48m and AU$9.53m worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by AU$37.5m.

The deficiency here weighs heavily on the AU$11.6m 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 definitely think shareholders need to watch this one closely. At the end of the day, Halo Food would probably need a major re-capitalization if its creditors were to demand repayment. There's no doubt that we learn most about debt from the balance sheet. But it is Halo Food'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.

In the last year Halo Food wasn't profitable at an EBIT level, but managed to grow its revenue by 36%, to AU$74m. Shareholders probably have their fingers crossed that it can grow its way to profits.

Caveat Emptor

Despite the top line growth, Halo Food still had an earnings before interest and tax (EBIT) loss over the last year. Its EBIT loss was a whopping AU$7.8m. If you consider the significant liabilities mentioned above, we are extremely wary of this investment. Of course, it may be able to improve its situation with a bit of luck and good execution. But we think that is unlikely, given it is low on liquid assets, and burned through AU$4.9m in the last year. So we consider this a high risk stock and we wouldn't be at all surprised if the company asks shareholders for money before long. 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. For example, we've discovered 4 warning signs for Halo Food (3 are significant!) that you should be aware of before investing here.

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.