We Think ORGANIC Farma Zdrowia (WSE:ORG) Is Taking Some Risk With Its 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.' 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 ORGANIC Farma Zdrowia S.A. (WSE:ORG) does have debt on its balance sheet. But the more important question is: how much risk is that debt creating?

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. 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, 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.

See our latest analysis for ORGANIC Farma Zdrowia

What Is ORGANIC Farma Zdrowia's Debt?

You can click the graphic below for the historical numbers, but it shows that ORGANIC Farma Zdrowia had zł9.13m of debt in March 2024, down from zł16.9m, one year before. However, because it has a cash reserve of zł1.23m, its net debt is less, at about zł7.90m.

How Healthy Is ORGANIC Farma Zdrowia's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that ORGANIC Farma Zdrowia had liabilities of zł17.9m due within 12 months and liabilities of zł7.17m due beyond that. On the other hand, it had cash of zł1.23m and zł8.30m worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by zł15.5m.

This deficit isn't so bad because ORGANIC Farma Zdrowia is worth zł49.5m, and thus could probably raise enough capital to shore up its balance sheet, if the need arose. But it's clear that we should definitely closely examine whether it can manage its debt without dilution.

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.

ORGANIC Farma Zdrowia's net debt is sitting at a very reasonable 2.2 times its EBITDA, while its EBIT covered its interest expense just 4.7 times last year. While these numbers do not alarm us, it's worth noting that the cost of the company's debt is having a real impact. Notably, ORGANIC Farma Zdrowia made a loss at the EBIT level, last year, but improved that to positive EBIT of zł1.8m in the last twelve months. There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since ORGANIC Farma Zdrowia 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.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. So it is important to check how much of its earnings before interest and tax (EBIT) converts to actual free cash flow. Over the last year, ORGANIC Farma Zdrowia reported free cash flow worth 9.3% of its EBIT, which is really quite low. For us, cash conversion that low sparks a little paranoia about is ability to extinguish debt.

Our View

ORGANIC Farma Zdrowia's conversion of EBIT to free cash flow was a real negative on this analysis, although the other factors we considered cast it in a significantly better light. For example, its EBIT growth rate is relatively strong. Taking the abovementioned factors together we do think ORGANIC Farma Zdrowia's debt poses some risks to the business. 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. However, not all investment risk resides within the balance sheet - far from it. For example ORGANIC Farma Zdrowia has 4 warning signs (and 3 which are potentially serious) we think you should know about.

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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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.