Is Oriental Food Industries Holdings Berhad (KLSE:OFI) Using Too Much 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.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. Importantly, Oriental Food Industries Holdings Berhad (KLSE:OFI) does carry debt. But should shareholders be worried about its use of debt?

When Is Debt Dangerous?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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. Of course, plenty of companies use debt to fund growth, without any negative consequences. When we examine debt levels, we first consider both cash and debt levels, together.

View our latest analysis for Oriental Food Industries Holdings Berhad

How Much Debt Does Oriental Food Industries Holdings Berhad Carry?

As you can see below, Oriental Food Industries Holdings Berhad had RM12.0m of debt at September 2020, down from RM17.6m a year prior. But on the other hand it also has RM29.8m in cash, leading to a RM17.8m net cash position.

How Strong Is Oriental Food Industries Holdings Berhad's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Oriental Food Industries Holdings Berhad had liabilities of RM37.8m due within 12 months and liabilities of RM18.5m due beyond that. Offsetting these obligations, it had cash of RM29.8m as well as receivables valued at RM50.3m due within 12 months. So it actually has RM23.8m more liquid assets than total liabilities.

This surplus suggests that Oriental Food Industries Holdings Berhad has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Succinctly put, Oriental Food Industries Holdings Berhad boasts net cash, so it's fair to say it does not have a heavy debt load!

Also good is that Oriental Food Industries Holdings Berhad grew its EBIT at 20% over the last year, further increasing its ability to manage debt. The balance sheet is clearly the area to focus on when you are analysing debt. But it is Oriental Food Industries Holdings Berhad'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, while the tax-man may adore accounting profits, lenders only accept cold hard cash. Oriental Food Industries Holdings Berhad 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. Happily for any shareholders, Oriental Food Industries Holdings Berhad actually produced more free cash flow than EBIT over the last three years. That sort of strong cash generation warms our hearts like a puppy in a bumblebee suit.

Summing up

While it is always sensible to investigate a company's debt, in this case Oriental Food Industries Holdings Berhad has RM17.8m in net cash and a decent-looking balance sheet. The cherry on top was that in converted 145% of that EBIT to free cash flow, bringing in RM26m. So we don't think Oriental Food Industries Holdings Berhad's use of debt is risky. 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. Case in point: We've spotted 3 warning signs for Oriental Food Industries Holdings Berhad you should be aware of, and 1 of them doesn't sit too well with us.

At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.

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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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