Agria Group Holding AD (BUL:AGH) Takes On Some Risk With Its Use Of 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 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 Agria Group Holding AD (BUL:AGH) 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 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. 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. 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. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

Check out our latest analysis for Agria Group Holding AD

What Is Agria Group Holding AD's Net Debt?

The image below, which you can click on for greater detail, shows that at March 2022 Agria Group Holding AD had debt of лв195.3m, up from лв183.0m in one year. Net debt is about the same, since the it doesn't have much cash.

A Look At Agria Group Holding AD's Liabilities

The latest balance sheet data shows that Agria Group Holding AD had liabilities of лв253.0m due within a year, and liabilities of лв54.3m falling due after that. On the other hand, it had cash of лв3.40m and лв111.1m worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by лв192.7m.

This deficit is considerable relative to its market capitalization of лв207.4m, so it does suggest shareholders should keep an eye on Agria Group Holding AD's use of debt. Should its lenders demand that it shore up the balance sheet, shareholders would likely face severe dilution.

We measure a company's debt load relative to its earnings power by looking at its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and by calculating how easily its earnings before interest and tax (EBIT) cover its interest expense (interest cover). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

Agria Group Holding AD has a debt to EBITDA ratio of 3.8, which signals significant debt, but is still pretty reasonable for most types of business. But its EBIT was about 17.7 times its interest expense, implying the company isn't really paying a high cost to maintain that level of debt. Even were the low cost to prove unsustainable, that is a good sign. Pleasingly, Agria Group Holding AD is growing its EBIT faster than former Australian PM Bob Hawke downs a yard glass, boasting a 179% gain in the last twelve months. There's no doubt that we learn most about debt from the balance sheet. But ultimately the future profitability of the business will decide if Agria Group Holding AD can strengthen its balance sheet over time. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. Over the last three years, Agria Group Holding AD reported free cash flow worth 15% of its EBIT, which is really quite low. That limp level of cash conversion undermines its ability to manage and pay down debt.

Our View

Even if we have reservations about how easily Agria Group Holding AD is capable of staying on top of its total liabilities, its interest cover and EBIT growth rate make us think feel relatively unconcerned. We think that Agria Group Holding AD's debt does make it a bit risky, after considering the aforementioned data points together. Not all risk is bad, as it can boost share price returns if it pays off, but this debt risk is worth keeping in mind. 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 Agria Group Holding AD is showing 3 warning signs in our investment analysis , and 2 of those make us uncomfortable...

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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

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.