ADF Foods (NSE:ADFFOODS) Could Easily Take On More 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. We note that ADF Foods Limited (NSE:ADFFOODS) does have debt on its balance sheet. But should shareholders be worried about its use of debt?

What Risk Does Debt Bring?

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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we examine debt levels, we first consider both cash and debt levels, together.

See our latest analysis for ADF Foods

What Is ADF Foods's Debt?

You can click the graphic below for the historical numbers, but it shows that as of September 2021 ADF Foods had ₹148.4m of debt, an increase on ₹130.3m, over one year. But it also has ₹732.3m in cash to offset that, meaning it has ₹583.8m net cash.

How Healthy Is ADF Foods' Balance Sheet?

We can see from the most recent balance sheet that ADF Foods had liabilities of ₹677.2m falling due within a year, and liabilities of ₹571.5m due beyond that. On the other hand, it had cash of ₹732.3m and ₹735.8m worth of receivables due within a year. So it actually has ₹219.4m more liquid assets than total liabilities.

This state of affairs indicates that ADF Foods' balance sheet looks quite solid, as its total liabilities are just about equal to its liquid assets. So while it's hard to imagine that the ₹17.7b company is struggling for cash, we still think it's worth monitoring its balance sheet. Succinctly put, ADF Foods boasts net cash, so it's fair to say it does not have a heavy debt load!

On top of that, ADF Foods grew its EBIT by 57% 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 it is ADF 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. ADF Foods 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. Looking at the most recent three years, ADF Foods recorded free cash flow of 37% of its EBIT, which is weaker than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.

Summing up

While it is always sensible to investigate a company's debt, in this case ADF Foods has ₹583.8m in net cash and a decent-looking balance sheet. And we liked the look of last year's 57% year-on-year EBIT growth. So we don't think ADF Foods's use of debt is risky. 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. To that end, you should learn about the 2 warning signs we've spotted with ADF Foods (including 1 which is a bit unpleasant) .

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. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. 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.