Is Eggriculture Foods (HKG:8609) Using Too Much Debt?

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 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 the real question is whether this debt is making the company risky.

When Is Debt Dangerous?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we think about a company's use of debt, we first look at cash and debt together.

View our latest analysis for Eggriculture Foods

What Is Eggriculture Foods's Debt?

The image below, which you can click on for greater detail, shows that at September 2020 Eggriculture Foods had debt of S$10.6m, up from S$9.10m in one year. However, its balance sheet shows it holds S$13.8m in cash, so it actually has S$3.29m net cash.

How Healthy Is Eggriculture Foods's Balance Sheet?

The latest balance sheet data shows that Eggriculture Foods had liabilities of S$12.6m due within a year, and liabilities of S$10.0m falling due after that. On the other hand, it had cash of S$13.8m and S$7.18m worth of receivables due within a year. So it has liabilities totalling S$1.55m more than its cash and near-term receivables, combined.

Of course, Eggriculture Foods has a market capitalization of S$30.1m, so these liabilities are probably manageable. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time. While it does have liabilities worth noting, Eggriculture Foods also has more cash than debt, so we're pretty confident it can manage its debt safely.

On top of that, Eggriculture Foods grew its EBIT by 54% over the last twelve months, and that growth will make it easier to handle its debt. The balance sheet is clearly the area to focus on when you are analysing debt. But you can't view debt in total isolation; since Eggriculture Foods 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.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. 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 last three years, Eggriculture Foods recorded free cash flow worth a fulsome 94% of its EBIT, which is stronger than we'd usually expect. That puts it in a very strong position to pay down debt.

Summing up

We could understand if investors are concerned about Eggriculture Foods's liabilities, but we can be reassured by the fact it has has net cash of S$3.29m. The cherry on top was that in converted 94% of that EBIT to free cash flow, bringing in S$6.7m. 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. Case in point: We've spotted 2 warning signs for Eggriculture Foods you should be aware of.

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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