Is Real Good Food (LON:RGD) Using Debt In A Risky Way?

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.' 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, Real Good Food plc (LON:RGD) does carry debt. But is this debt a concern to shareholders?

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. 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. Of course, plenty of companies use debt to fund growth, without any negative consequences. The first step when considering a company's debt levels is to consider its cash and debt together.

See our latest analysis for Real Good Food

How Much Debt Does Real Good Food Carry?

The image below, which you can click on for greater detail, shows that at September 2020 Real Good Food had debt of UK£46.7m, up from UK£41.1m in one year. However, it does have UK£2.34m in cash offsetting this, leading to net debt of about UK£44.3m.

A Look At Real Good Food's Liabilities

According to the last reported balance sheet, Real Good Food had liabilities of UK£17.5m due within 12 months, and liabilities of UK£54.7m due beyond 12 months. Offsetting these obligations, it had cash of UK£2.34m as well as receivables valued at UK£9.76m due within 12 months. So its liabilities total UK£60.1m more than the combination of its cash and short-term receivables.

The deficiency here weighs heavily on the UK£3.73m 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'd watch its balance sheet closely, without a doubt. At the end of the day, Real Good 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 you can't view debt in total isolation; since Real Good Food will need earnings to service that debt. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

In the last year Real Good Food had a loss before interest and tax, and actually shrunk its revenue by 8.8%, to UK£58m. We would much prefer see growth.

Caveat Emptor

Over the last twelve months Real Good Food produced an earnings before interest and tax (EBIT) loss. Its EBIT loss was a whopping UK£2.7m. Reflecting on this and the significant total liabilities, it's hard to know what to say about the stock because of our intense dis-affinity for it. Like every long-shot we're sure it has a glossy presentation outlining its blue-sky potential. But the reality is that it is low on liquid assets relative to liabilities, and it lost UK£20m in the last year. So we think buying this stock is risky. 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. To that end, you should learn about the 3 warning signs we've spotted with Real Good Food (including 2 which don't sit too well with us) .

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. 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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