Stock Analysis

Is Heritage Foods (NSE:HERITGFOOD) Using Too Much Debt?

NSEI:HERITGFOOD
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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.' 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 Heritage Foods Limited (NSE:HERITGFOOD) does have debt on its balance sheet. But should shareholders be worried about its use of debt?

Why Does Debt Bring Risk?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. When we think about a company's use of debt, we first look at cash and debt together.

See our latest analysis for Heritage Foods

How Much Debt Does Heritage Foods Carry?

The image below, which you can click on for greater detail, shows that Heritage Foods had debt of ₹295.4m at the end of March 2021, a reduction from ₹3.06b over a year. However, it does have ₹235.6m in cash offsetting this, leading to net debt of about ₹59.8m.

debt-equity-history-analysis
NSEI:HERITGFOOD Debt to Equity History May 25th 2021

How Healthy Is Heritage Foods' Balance Sheet?

The latest balance sheet data shows that Heritage Foods had liabilities of ₹2.08b due within a year, and liabilities of ₹742.7m falling due after that. On the other hand, it had cash of ₹235.6m and ₹218.5m worth of receivables due within a year. So it has liabilities totalling ₹2.37b more than its cash and near-term receivables, combined.

Given Heritage Foods has a market capitalization of ₹15.6b, it's hard to believe these liabilities pose much threat. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time. But either way, Heritage Foods has virtually no net debt, so it's fair to say it does not have a heavy debt load!

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

With debt at a measly 0.022 times EBITDA and EBIT covering interest a whopping 11.7 times, it's clear that Heritage Foods is not a desperate borrower. So relative to past earnings, the debt load seems trivial. Even more impressive was the fact that Heritage Foods grew its EBIT by 169% over twelve months. That boost will make it even easier to pay down debt going forward. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Heritage Foods's ability to maintain a healthy balance sheet going forward. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So it's worth checking how much of that EBIT is backed by free cash flow. In the last three years, Heritage Foods created free cash flow amounting to 14% of its EBIT, an uninspiring performance. For us, cash conversion that low sparks a little paranoia about is ability to extinguish debt.

Our View

Heritage Foods's EBIT growth rate suggests it can handle its debt as easily as Cristiano Ronaldo could score a goal against an under 14's goalkeeper. But, on a more sombre note, we are a little concerned by its conversion of EBIT to free cash flow. Taking all this data into account, it seems to us that Heritage Foods takes a pretty sensible approach to debt. That means they are taking on a bit more risk, in the hope of boosting shareholder returns. 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. For example - Heritage Foods has 1 warning sign we think 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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