Is Euro India Fresh Foods (NSE:EIFFL) Using Too Much Debt?

Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' 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. As with many other companies Euro India Fresh Foods Limited (NSE:EIFFL) makes use of debt. But the real question is whether this debt is making the company risky.

Why Does Debt Bring Risk?

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 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 think about a company's use of debt, we first look at cash and debt together.

Check out our latest analysis for Euro India Fresh Foods

How Much Debt Does Euro India Fresh Foods Carry?

The image below, which you can click on for greater detail, shows that at September 2021 Euro India Fresh Foods had debt of ₹323.2m, up from ₹281.3m in one year. However, it also had ₹7.10m in cash, and so its net debt is ₹316.1m.

How Strong Is Euro India Fresh Foods' Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Euro India Fresh Foods had liabilities of ₹443.6m due within 12 months and liabilities of ₹102.9m due beyond that. Offsetting this, it had ₹7.10m in cash and ₹182.6m in receivables that were due within 12 months. So it has liabilities totalling ₹356.8m more than its cash and near-term receivables, combined.

Given Euro India Fresh Foods has a market capitalization of ₹2.84b, it's hard to believe these liabilities pose much threat. Having said that, it's clear that we should continue to monitor its balance sheet, lest it change for the worse.

In order to size up a company's debt relative to its earnings, we calculate its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and its earnings before interest and tax (EBIT) divided by its interest expense (its interest cover). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

While we wouldn't worry about Euro India Fresh Foods's net debt to EBITDA ratio of 3.0, we think its super-low interest cover of 2.3 times is a sign of high leverage. So shareholders should probably be aware that interest expenses appear to have really impacted the business lately. However, the silver lining was that Euro India Fresh Foods achieved a positive EBIT of ₹78m in the last twelve months, an improvement on the prior year's loss. The balance sheet is clearly the area to focus on when you are analysing debt. But it is Euro India Fresh Foods's earnings that will influence how the balance sheet holds up in the future. 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.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. So it's worth checking how much of the earnings before interest and tax (EBIT) is backed by free cash flow. Over the last year, Euro India Fresh Foods recorded negative free cash flow, in total. Debt is usually more expensive, and almost always more risky in the hands of a company with negative free cash flow. Shareholders ought to hope for an improvement.

Our View

Both Euro India Fresh Foods's interest cover and its conversion of EBIT to free cash flow were discouraging. At least its level of total liabilities gives us reason to be optimistic. When we consider all the factors discussed, it seems to us that Euro India Fresh 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. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. For example, we've discovered 3 warning signs for Euro India Fresh Foods (1 is concerning!) that you should be aware of before investing here.

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. 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.