Does AgraFlora Organics International (CSE:AGRA) Have A Healthy Balance Sheet?

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.' 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. As with many other companies AgraFlora Organics International Inc. (CSE:AGRA) makes use of debt. But the real question is whether this debt is making the company risky.

When Is Debt A Problem?

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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. 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 thing to do when considering how much debt a business uses is to look at its cash and debt together.

See our latest analysis for AgraFlora Organics International

How Much Debt Does AgraFlora Organics International Carry?

The image below, which you can click on for greater detail, shows that at September 2020 AgraFlora Organics International had debt of CA$29.1m, up from none in one year. Net debt is about the same, since the it doesn't have much cash.

A Look At AgraFlora Organics International's Liabilities

Zooming in on the latest balance sheet data, we can see that AgraFlora Organics International had liabilities of CA$9.12m due within 12 months and liabilities of CA$46.7m due beyond that. Offsetting these obligations, it had cash of CA$226.3k as well as receivables valued at CA$581.1k due within 12 months. So it has liabilities totalling CA$55.0m more than its cash and near-term receivables, combined.

This is a mountain of leverage relative to its market capitalization of CA$91.4m. This suggests shareholders would be heavily diluted if the company needed to shore up its balance sheet in a hurry.

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.

Weak interest cover of 0.40 times and a disturbingly high net debt to EBITDA ratio of 16.3 hit our confidence in AgraFlora Organics International like a one-two punch to the gut. This means we'd consider it to have a heavy debt load. However, the silver lining was that AgraFlora Organics International achieved a positive EBIT of CA$1.8m in the last twelve months, an improvement on the prior year's loss. There's no doubt that we learn most about debt from the balance sheet. But it is future earnings, more than anything, that will determine AgraFlora Organics International's ability to maintain a healthy balance sheet going forward. 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 it is important to check how much of its earnings before interest and tax (EBIT) converts to actual free cash flow. Over the last year, AgraFlora Organics International reported free cash flow worth 19% 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

To be frank both AgraFlora Organics International's net debt to EBITDA and its track record of covering its interest expense with its EBIT make us rather uncomfortable with its debt levels. But at least its EBIT growth rate is not so bad. Looking at the bigger picture, it seems clear to us that AgraFlora Organics International's use of debt is creating risks for the company. If everything goes well that may pay off but the downside of this debt is a greater risk of permanent losses. 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 example AgraFlora Organics International has 6 warning signs (and 2 which are a bit concerning) we think you should know about.

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

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This article by Simply Wall St is general in nature. 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.
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