Is NutryFarm International (SGX:AZT) A Risky Investment?

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. We note that NutryFarm International Limited (SGX:AZT) does have debt on its balance sheet. But is this debt a concern to shareholders?

Why Does Debt Bring Risk?

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. 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.

See our latest analysis for NutryFarm International

What Is NutryFarm International's Debt?

As you can see below, at the end of December 2020, NutryFarm International had HK$144.2m of debt, up from HK$138.0m a year ago. Click the image for more detail. However, it does have HK$6.66m in cash offsetting this, leading to net debt of about HK$137.5m.

How Strong Is NutryFarm International's Balance Sheet?

The latest balance sheet data shows that NutryFarm International had liabilities of HK$95.5m due within a year, and liabilities of HK$85.5m falling due after that. Offsetting this, it had HK$6.66m in cash and HK$13.5m in receivables that were due within 12 months. So its liabilities total HK$160.9m more than the combination of its cash and short-term receivables.

This is a mountain of leverage relative to its market capitalization of HK$250.0m. This suggests shareholders would be heavily diluted if the company needed to shore up its balance sheet in a hurry. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since NutryFarm International will need earnings to service that debt. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

In the last year NutryFarm International wasn't profitable at an EBIT level, but managed to grow its revenue by 6.0%, to HK$43m. That rate of growth is a bit slow for our taste, but it takes all types to make a world.

Caveat Emptor

Over the last twelve months NutryFarm International produced an earnings before interest and tax (EBIT) loss. To be specific the EBIT loss came in at HK$9.1m. When we look at that and recall the liabilities on its balance sheet, relative to cash, it seems unwise to us for the company to have any debt. Quite frankly we think the balance sheet is far from match-fit, although it could be improved with time. However, it doesn't help that it burned through HK$8.7m of cash over the last year. So suffice it to say we do consider the stock to be risky. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. These risks can be hard to spot. Every company has them, and we've spotted 5 warning signs for NutryFarm International (of which 2 can't be ignored!) 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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