Is Eggriculture Foods (HKG:8609) A Risky Investment?

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. As with many other companies Eggriculture Foods Ltd. (HKG:8609) makes use of debt. But should shareholders be worried about its use of debt?

What Risk Does Debt Bring?

Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. The first step when considering a company's debt levels is to consider its cash and debt together.

See our latest analysis for Eggriculture Foods

What Is Eggriculture Foods's Debt?

You can click the graphic below for the historical numbers, but it shows that as of September 2020 Eggriculture Foods had S$10.6m of debt, an increase on S$8.33m, over one year. However, it does have S$13.8m in cash offsetting this, leading to net cash of S$3.29m.

How Strong Is Eggriculture Foods' Balance Sheet?

We can see from the most recent balance sheet that Eggriculture Foods had liabilities of S$12.6m falling due within a year, and liabilities of S$10.0m due beyond that. On the other hand, it had cash of S$13.8m and S$7.18m worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by S$1.55m.

Since publicly traded Eggriculture Foods shares are worth a total of S$30.3m, it seems unlikely that this level of liabilities would be a major threat. Having said that, it's clear that we should continue to monitor its balance sheet, lest it change for the worse. Despite its noteworthy liabilities, Eggriculture Foods boasts net cash, so it's fair to say it does not have a heavy debt load!

In addition to that, we're happy to report that Eggriculture Foods has boosted its EBIT by 44%, thus reducing the spectre of future debt repayments. When analysing debt levels, the balance sheet is the obvious place to start. But it is Eggriculture Foods's earnings that will influence how the balance sheet holds up in the future. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. While Eggriculture Foods has net cash on its balance sheet, it's still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. Over the most recent three years, Eggriculture Foods recorded free cash flow worth 79% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This cold hard cash means it can reduce its debt when it wants to.

Summing up

While it is always sensible to look at a company's total liabilities, it is very reassuring that Eggriculture Foods has S$3.29m in net cash. And we liked the look of last year's 44% year-on-year EBIT growth. So is Eggriculture Foods's debt a risk? It doesn't seem so to us. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. To that end, you should be aware of the 2 warning signs we've spotted with Eggriculture Foods .

If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.

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