Is KSG Agro (WSE:KSG) Using Too Much Debt?

The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' 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. We note that KSG Agro S.A. (WSE:KSG) does have debt on its balance sheet. But should shareholders be worried about its use of debt?

When Is Debt A Problem?

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 common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. Of course, plenty of companies use debt to fund growth, without any negative consequences. When we think about a company's use of debt, we first look at cash and debt together.

See our latest analysis for KSG Agro

What Is KSG Agro's Debt?

As you can see below, KSG Agro had US$31.3m of debt at September 2020, down from US$33.4m a year prior. And it doesn't have much cash, so its net debt is about the same.

How Healthy Is KSG Agro's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that KSG Agro had liabilities of US$31.5m due within 12 months and liabilities of US$26.7m due beyond that. Offsetting this, it had US$187.0k in cash and US$4.81m in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by US$53.3m.

This deficit casts a shadow over the US$9.50m company, like a colossus towering over mere mortals. So we'd watch its balance sheet closely, without a doubt. 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). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

KSG Agro's net debt is sitting at a very reasonable 2.5 times its EBITDA, while its EBIT covered its interest expense just 3.5 times last year. While that doesn't worry us too much, it does suggest the interest payments are somewhat of a burden. One redeeming factor for KSG Agro is that it turned last year's EBIT loss into a gain of US$12m, over the last twelve months. When analysing debt levels, the balance sheet is the obvious place to start. But it is KSG Agro'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, while the tax-man may adore accounting profits, lenders only accept cold hard cash. 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, KSG Agro recorded negative free cash flow, in total. Debt is far more risky for companies with unreliable free cash flow, so shareholders should be hoping that the past expenditure will produce free cash flow in the future.

Our View

On the face of it, KSG Agro's conversion of EBIT to free cash flow left us tentative about the stock, and its level of total liabilities was no more enticing than the one empty restaurant on the busiest night of the year. But at least its EBIT growth rate is not so bad. After considering the datapoints discussed, we think KSG Agro has too much debt. That sort of riskiness is ok for some, but it certainly doesn't float our boat. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. For instance, we've identified 5 warning signs for KSG Agro (2 can't be ignored) you should be aware of.

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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