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 note that Zarneni Hrani Bulgaria AD (BUL:ZHBG) does have debt on its balance sheet. But the more important question is: how much risk is that debt creating?
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. 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. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.
As you can see below, Zarneni Hrani Bulgaria AD had лв41.8m of debt at June 2023, down from лв46.8m a year prior. However, because it has a cash reserve of лв7.85m, its net debt is less, at about лв34.0m.
According to the last reported balance sheet, Zarneni Hrani Bulgaria AD had liabilities of лв44.6m due within 12 months, and liabilities of лв49.7m due beyond 12 months. On the other hand, it had cash of лв7.85m and лв78.2m worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by лв8.25m.
Zarneni Hrani Bulgaria AD has a market capitalization of лв23.9m, so it could very likely raise cash to ameliorate its balance sheet, if the need arose. But we definitely want to keep our eyes open to indications that its debt is bringing too much risk.
We use two main ratios to inform us about debt levels relative to earnings. The first is net debt divided by earnings before interest, tax, depreciation, and amortization (EBITDA), while the second is how many times its earnings before interest and tax (EBIT) covers its interest expense (or its interest cover, for short). 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).
Zarneni Hrani Bulgaria AD's net debt is 2.7 times its EBITDA, which is a significant but still reasonable amount of leverage. However, its interest coverage of 1k is very high, suggesting that the interest expense on the debt is currently quite low. Notably, Zarneni Hrani Bulgaria AD's EBIT launched higher than Elon Musk, gaining a whopping 107% on last year. There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since Zarneni Hrani Bulgaria AD 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.
Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. So we always check how much of that EBIT is translated into free cash flow. Over the last three years, Zarneni Hrani Bulgaria AD actually produced more free cash flow than EBIT. That sort of strong cash conversion gets us as excited as the crowd when the beat drops at a Daft Punk concert.
The good news is that Zarneni Hrani Bulgaria AD's demonstrated ability to cover its interest expense with its EBIT delights us like a fluffy puppy does a toddler. But truth be told we feel its net debt to EBITDA does undermine this impression a bit. Zooming out, Zarneni Hrani Bulgaria AD seems to use debt quite reasonably; and that gets the nod from us. While debt does bring risk, when used wisely it can also bring a higher return on equity. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. To that end, you should learn about the 2 warning signs we've spotted with Zarneni Hrani Bulgaria AD (including 1 which can't be ignored) .
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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