Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' 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. Importantly, Zarneni Hrani Bulgaria AD (BUL:T43) does carry debt. But is this debt a concern to shareholders?
When Is Debt Dangerous?
Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. The first step when considering a company's debt levels is to consider its cash and debt together.
What Is Zarneni Hrani Bulgaria AD's Net Debt?
As you can see below, Zarneni Hrani Bulgaria AD had лв35.0m of debt at September 2020, down from лв38.3m a year prior. However, it does have лв39.8m in cash offsetting this, leading to net cash of лв4.79m.
How Strong Is Zarneni Hrani Bulgaria AD's Balance Sheet?
The latest balance sheet data shows that Zarneni Hrani Bulgaria AD had liabilities of лв46.8m due within a year, and liabilities of лв47.1m falling due after that. On the other hand, it had cash of лв39.8m and лв54.6m worth of receivables due within a year. So its total liabilities are just about perfectly matched by its shorter-term, liquid assets.
This surplus suggests that Zarneni Hrani Bulgaria AD has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Simply put, the fact that Zarneni Hrani Bulgaria AD has more cash than debt is arguably a good indication that it can manage its debt safely.
It is just as well that Zarneni Hrani Bulgaria AD's load is not too heavy, because its EBIT was down 96% over the last year. When a company sees its earnings tank, it can sometimes find its relationships with its lenders turn sour. The balance sheet is clearly the area to focus on when you are analysing debt. But it is Zarneni Hrani Bulgaria AD'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.
Finally, a company can only pay off debt with cold hard cash, not accounting profits. Zarneni Hrani Bulgaria AD may have net cash on the balance sheet, but it is still interesting to look at how well the business converts its earnings before interest and tax (EBIT) to free cash flow, because that will influence both its need for, and its capacity to manage debt. Happily for any shareholders, Zarneni Hrani Bulgaria AD actually produced more free cash flow than EBIT over the last three years. That sort of strong cash conversion gets us as excited as the crowd when the beat drops at a Daft Punk concert.
While it is always sensible to investigate a company's debt, in this case Zarneni Hrani Bulgaria AD has лв4.79m in net cash and a decent-looking balance sheet. And it impressed us with free cash flow of лв7.3m, being 231% of its EBIT. So we don't have any problem with Zarneni Hrani Bulgaria AD's use of debt. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. For instance, we've identified 4 warning signs for Zarneni Hrani Bulgaria AD (1 is potentially serious) you should be aware of.
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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