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Highlights
- Retail Food Group (ASX:RFG) manages debt effectively.
- EBIT to free cash flow conversion is strong.
- Interest coverage ratio requires attention.
David Iben wisely stated, "Volatility is not a risk we care about. What we care about is avoiding the permanent loss of capital." This insight underscores the importance of evaluating a company's balance sheet, as debt can be a critical factor in business collapses. A closer look at Retail Food Group Limited (ASX:RFG), which operates with debt, raises questions about the implications for shareholders.
Understanding When Debt Becomes Problematic
Debt presents challenges when a company struggles to repay it, either through raising capital or using cash flow. Bankruptcy is rare but remains possible if obligations aren't met. Often, indebted companies might dilute shareholder value under lender pressure. However, debt can also provide affordable capital if it substitutes dilution in a company able to reinvest at high yields. Evaluating debt levels involves examining both cash and debts closely.
Retail Food Group's Debt Position
In December 2024, Retail Food Group had AU$24.8 million in debt, similar to the prior year but balanced by AU$21.4 million in cash, resulting in a net debt of around AU$3.39 million. Examining the most recent balance sheet reveals short-term liabilities of AU$52.5 million and long-term obligations of AU$106.5 million. With cash and receivables under AU$55 million, liabilities outweighed liquid assets by AU$103.9 million, suggesting a situation worth monitoring, as large deficits often signal financial challenges.
Financial Ratios and Balance Sheet Strength
Two core ratios are utilized to assess debt related to earnings: net debt to EBITDA and EBIT interest coverage. Surprisingly, despite a net debt ratio of just 0.24 times EBITDA, Retail Food Group's EBIT interest coverage is only 2.5 times. The jump in EBIT by 390% last year is noteworthy, but the leverage still cannot be ignored. The conversion of EBIT to more free cash flow over the last three years adds a positive dimension to the analysis.
Future Considerations
While the balance sheet offers substantial insights into debt management, the ultimate determinant for Retail Food Group will be its future profitability. This ability to convert earnings into free cash is promising, yet the interest coverage requires continued observation. The leverage presents opportunities for enhanced equity returns but demands careful oversight.
Although the focus remains on the balance sheet, it is crucial to recognize and evaluate other potential risks. For those interested, a list of growth stocks with zero net debt is available, providing alternative avenues for consideration.
