Is Apex Frozen Foods (NSE:APEX) Using Too Much Debt?

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 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. We note that Apex Frozen Foods Limited (NSE:APEX) does have debt on its balance sheet. But should shareholders be worried about its use of debt?

What Risk Does Debt Bring?

Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. The first step when considering a company's debt levels is to consider its cash and debt together.

See our latest analysis for Apex Frozen Foods

What Is Apex Frozen Foods's Debt?

You can click the graphic below for the historical numbers, but it shows that as of September 2020 Apex Frozen Foods had ₹1.63b of debt, an increase on ₹1.36b, over one year. However, it also had ₹151.8m in cash, and so its net debt is ₹1.47b.

A Look At Apex Frozen Foods' Liabilities

We can see from the most recent balance sheet that Apex Frozen Foods had liabilities of ₹2.14b falling due within a year, and liabilities of ₹210.0m due beyond that. Offsetting this, it had ₹151.8m in cash and ₹1.81b in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by ₹396.0m.

Since publicly traded Apex Frozen Foods shares are worth a total of ₹7.79b, it seems unlikely that this level of liabilities would be a major threat. But there are sufficient liabilities that we would certainly recommend shareholders continue to monitor the balance sheet, going forward.

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.

Apex Frozen Foods has net debt worth 1.8 times EBITDA, which isn't too much, but its interest cover looks a bit on the low side, with EBIT at only 5.7 times the interest expense. While that doesn't worry us too much, it does suggest the interest payments are somewhat of a burden. The bad news is that Apex Frozen Foods saw its EBIT decline by 16% over the last year. If earnings continue to decline at that rate then handling the debt will be more difficult than taking three children under 5 to a fancy pants restaurant. 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 Apex Frozen Foods will need earnings to service that debt. So if you're keen to discover more about its earnings, it might be worth checking out this graph of its long term earnings trend.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. Over the last three years, Apex Frozen Foods reported free cash flow worth 6.0% 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

Both Apex Frozen Foods's EBIT growth rate and its conversion of EBIT to free cash flow were discouraging. But its not so bad at staying on top of its total liabilities. When we consider all the factors discussed, it seems to us that Apex Frozen Foods is taking some risks with its use of debt. While that debt can boost returns, we think the company has enough leverage now. 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. For instance, we've identified 2 warning signs for Apex Frozen Foods that you should be aware of.

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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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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