We Think Agro Tech Foods (NSE:ATFL) Is Taking Some Risk With Its 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.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. We can see that Agro Tech Foods Limited (NSE:ATFL) does use debt in its business. But is this debt a concern to shareholders?

When Is Debt A Problem?

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. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. 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.

Check out our latest analysis for Agro Tech Foods

How Much Debt Does Agro Tech Foods Carry?

The chart below, which you can click on for greater detail, shows that Agro Tech Foods had ₹325.9m in debt in September 2022; about the same as the year before. However, because it has a cash reserve of ₹49.2m, its net debt is less, at about ₹276.7m.

A Look At Agro Tech Foods' Liabilities

We can see from the most recent balance sheet that Agro Tech Foods had liabilities of ₹1.27b falling due within a year, and liabilities of ₹250.2m due beyond that. Offsetting this, it had ₹49.2m in cash and ₹775.7m in receivables that were due within 12 months. So it has liabilities totalling ₹699.5m more than its cash and near-term receivables, combined.

Given Agro Tech Foods has a market capitalization of ₹22.6b, it's hard to believe these liabilities pose much threat. But there are sufficient liabilities that we would certainly recommend shareholders continue to monitor the balance sheet, going forward. But either way, Agro Tech Foods has virtually no net debt, so it's fair to say it does not have a heavy debt load!

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). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

With net debt sitting at just 0.71 times EBITDA, Agro Tech Foods is arguably pretty conservatively geared. And it boasts interest cover of 8.6 times, which is more than adequate. In fact Agro Tech Foods's saving grace is its low debt levels, because its EBIT has tanked 27% in the last twelve months. When a company sees its earnings tank, it can sometimes find its relationships with its lenders turn sour. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately the future profitability of the business will decide if Agro Tech Foods can strengthen its balance sheet over time. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. So it's worth checking how much of that EBIT is backed by free cash flow. During the last three years, Agro Tech Foods burned a lot of cash. While that may be a result of expenditure for growth, it does make the debt far more risky.

Our View

While Agro Tech Foods's conversion of EBIT to free cash flow makes us cautious about it, its track record of (not) growing its EBIT is no better. But on the brighter side of life, its net debt to EBITDA leaves us feeling more frolicsome. When we consider all the factors discussed, it seems to us that Agro Tech Foods is taking some risks with its use of debt. So while that leverage does boost returns on equity, we wouldn't really want to see it increase from here. 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 example, we've discovered 2 warning signs for Agro Tech Foods (1 doesn't sit too well with us!) that you should be aware of before investing here.

When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.

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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.