David Iben put it well when he said, “Volatility is not a risk we care about. What matters to us is to avoid the permanent loss of capital. ‘ So it seems like smart money knows that debt – which is usually involved in bankruptcies – is a very important factor, when you assess the level of risk of a business. We note that Golden Agri-Ressources Ltée (SGX: E5H) has debt on its balance sheet. But should shareholders be concerned about its use of debt?
What risk does debt entail?
Debts and other liabilities become risky for a business when it cannot easily meet these obligations, either with free cash flow or by raising capital at an attractive price. In the worst case scenario, a business can go bankrupt if it cannot pay its creditors. However, a more common (but still costly) event is when a company has to issue stock at bargain prices, constantly diluting shareholders, just to strengthen its balance sheet. By replacing dilution, however, debt can be a very good tool for companies that need capital to invest in growth at high rates of return. When we think of a business’s use of debt, we first look at cash flow and debt together.
See our latest analysis for Golden Agri-Ressources
What is the debt of Golden Agri-Resources?
The graph below, which you can click for more details, shows Golden Agri-Resources owed US $ 3.02 billion in debt as of June 2021; about the same as the year before. On the other hand, it has $ 1.04 billion in cash, resulting in net debt of around $ 1.98 billion.
How strong is Golden Agri-Ressources’ balance sheet?
We can see from the most recent balance sheet that Golden Agri-Resources had liabilities of US $ 2.81 billion due within one year and liabilities of US $ 1.80 billion due within one year. -of the. In return, he had $ 1.04 billion in cash and $ 612.0 million in receivables due within 12 months. As a result, its liabilities exceed the sum of its cash and (short-term) receivables by US $ 2.96 billion.
When you consider that this deficit exceeds the company’s US $ 2.17 billion market cap, you may well be inclined to take a close look at the balance sheet. In the scenario where the company had to clean up its balance sheet quickly, it seems likely that shareholders would suffer a significant dilution.
We measure a company’s debt load relative to its earning capacity by looking at its net debt divided by its earnings before interest, taxes, depreciation, and amortization (EBITDA) and calculating how easily its earnings before interest and taxes (EBIT) covers its interest costs (interest coverage). Thus, we look at debt over earnings with and without amortization charges.
Golden Agri-Resources’ net debt stands at a very reasonable level of 2.1 times its EBITDA, while its EBIT only covered its interest expense 4.9 times last year. While we’re not worried about these numbers, it’s worth noting that the cost of the company’s debt does have a real impact. Notably, Golden Agri-Resources’ EBIT was higher than Elon Musk’s, gaining a whopping 415% from last year. The balance sheet is clearly the area you need to focus on when analyzing debt. But it is future profits, more than anything, that will determine Golden Agri-Resources’ ability to maintain a healthy balance sheet in the future. So, if you want to see what the professionals think, you might find this free analyst earnings forecast report interesting.
But our last consideration is also important, because a company cannot pay its debts with paper profits; he needs hard cash. It is therefore worth checking to what extent this EBIT is supported by free cash flow. Over the past three years, Golden Agri-Resources has generated free cash flow of 96% of its EBIT, more than we expected. This puts him in a very strong position to pay off the debt.
Our point of view
Golden Agri-Resources’ conversion of EBIT into free cash flow was a real asset in this analysis, as was its EBIT growth rate. In contrast, our confidence was undermined by his apparent struggle to manage his total liabilities. When we consider all of the factors mentioned above, we feel a little cautious about Golden Agri-Resources’ use of debt. While we understand that debt can improve returns on equity, we suggest shareholders watch their debt level closely, lest they increase. When analyzing debt levels, the balance sheet is the obvious starting point. However, not all investment risks lie on the balance sheet – far from it. For example, we have identified 3 warning signs for Golden Agri-Ressources (2 make us uncomfortable), you should be aware of this.
At the end of the day, it’s often best to focus on businesses that don’t have net debt. You can access our special list of these companies (all with a history of profit growth). It’s free.
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