Auditors Are Concerned About KSG Agro (WSE:KSG)

When KSG Agro S.A. (WSE:KSG) reported its results to June 2022 its auditors, CLERC Réviseurs d’Entreprises could not be sure that it would be able to continue as a going concern in the next year. It is therefore fair to assume that, based on those financials, the company should strengthen its balance sheet in the short term, perhaps by issuing shares.

Given its situation, it may not be in a good position to raise capital on favorable terms. So it is suddenly extremely important to consider whether the company is taking too much risk on its balance sheet. The big consideration is whether it can repay its debt, since in the worst case scenario, creditors could force the company to bankruptcy.

Our analysis indicates that KSG is potentially undervalued!

What Is KSG Agro's Debt?

The chart below, which you can click on for greater detail, shows that KSG Agro had US$34.2m in debt in June 2022; about the same as the year before. Net debt is about the same, since the it doesn't have much cash.

How Strong Is KSG Agro's Balance Sheet?

The latest balance sheet data shows that KSG Agro had liabilities of US$17.7m due within a year, and liabilities of US$28.4m falling due after that. Offsetting these obligations, it had cash of US$283.0k as well as receivables valued at US$4.42m due within 12 months. So its liabilities total US$41.4m more than the combination of its cash and short-term receivables.

This deficit casts a shadow over the US$6.82m company, like a colossus towering over mere mortals. So we definitely think shareholders need to watch this one closely. After all, KSG Agro would likely require a major re-capitalisation if it had to pay its creditors today.

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). The advantage of this approach is that we take into account both the absolute quantum of debt (with net debt to EBITDA) and the actual interest expenses associated with that debt (with its interest cover ratio).

KSG Agro's debt is 2.6 times its EBITDA, and its EBIT cover its interest expense 3.9 times over. This suggests that while the debt levels are significant, we'd stop short of calling them problematic. Pleasingly, KSG Agro is growing its EBIT faster than former Australian PM Bob Hawke downs a yard glass, boasting a 4,682% gain in the last twelve months. The balance sheet is clearly the area to focus on when you are analysing debt. But you can't view debt in total isolation; since KSG Agro 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 we clearly need to look at whether that EBIT is leading to corresponding free cash flow. In the last two years, KSG Agro created free cash flow amounting to 13% of its EBIT, an uninspiring performance. For us, cash conversion that low sparks a little paranoia about is ability to extinguish debt.

Our View

Mulling over KSG Agro's attempt at staying on top of its total liabilities, we're certainly not enthusiastic. But on the bright side, its EBIT growth rate is a good sign, and makes us more optimistic. Looking at the bigger picture, it seems clear to us that KSG Agro's use of debt is creating risks for the company. If all goes well, that should boost returns, but on the flip side, the risk of permanent capital loss is elevated by the debt. Some investors may be interested in buying high risk stocks at the right price, but we prefer to avoid a company after its auditor has expressed any uncertainty about its ability to continue as a going concern. Our preference is to invest in companies that always make sure the auditor has confidence that the company will continue as a going concern. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. We've identified 5 warning signs with KSG Agro (at least 2 which are potentially serious) , and understanding them should be part of your investment process.

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

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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.