These 4 Measures Indicate That Kencana Agri (SGX:BNE) Is Using Debt Extensively

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.' 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. We can see that Kencana Agri Limited (SGX:BNE) does use debt in its business. But the real question is whether this debt is making the company risky.

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When Is Debt Dangerous?

Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. Of course, plenty of companies use debt to fund growth, without any negative consequences. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

What Is Kencana Agri's Net Debt?

The chart below, which you can click on for greater detail, shows that Kencana Agri had US$190.2m in debt in December 2024; about the same as the year before. However, it does have US$26.0m in cash offsetting this, leading to net debt of about US$164.2m.

How Healthy Is Kencana Agri's Balance Sheet?

According to the last reported balance sheet, Kencana Agri had liabilities of US$93.9m due within 12 months, and liabilities of US$153.5m due beyond 12 months. Offsetting these obligations, it had cash of US$26.0m as well as receivables valued at US$10.2m due within 12 months. So it has liabilities totalling US$211.2m more than its cash and near-term receivables, combined.

This deficit casts a shadow over the US$19.7m company, like a colossus towering over mere mortals. So we definitely think shareholders need to watch this one closely. After all, Kencana Agri would likely require a major re-capitalisation if it had to pay its creditors today.

Check out our latest analysis for Kencana Agri

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.

While we wouldn't worry about Kencana Agri's net debt to EBITDA ratio of 3.2, we think its super-low interest cover of 2.3 times is a sign of high leverage. It seems clear that the cost of borrowing money is negatively impacting returns for shareholders, of late. The silver lining is that Kencana Agri grew its EBIT by 302% last year, which nourishing like the idealism of youth. If that earnings trend continues it will make its debt load much more manageable in the future. There's no doubt that we learn most about debt from the balance sheet. But it is Kencana Agri'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 that EBIT is backed by free cash flow. Over the last three years, Kencana Agri actually produced more free cash flow than EBIT. There's nothing better than incoming cash when it comes to staying in your lenders' good graces.

Our View

We feel some trepidation about Kencana Agri's difficulty level of total liabilities, but we've got positives to focus on, too. For example, its conversion of EBIT to free cash flow and EBIT growth rate give us some confidence in its ability to manage its debt. When we consider all the factors discussed, it seems to us that Kencana Agri is taking some risks with its use of debt. While that debt can boost returns, we think the company has enough leverage now. 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 instance, we've identified 3 warning signs for Kencana Agri (2 are a bit concerning) you should be aware of.

When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.

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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.