David Iben said it well when he said: “Volatility is not a risk that interests us. What matters to us is to avoid the permanent loss of capital. It’s natural to consider a company’s balance sheet when looking at its riskiness, as debt is often involved when a company fails. We can see that HF Foods Group Inc. (NASDAQ:HFFG) uses debt in its business. But the real question is whether this debt makes the business risky.

Why is debt risky?

Debt is a tool to help businesses grow, but if a business is unable to repay its lenders, it exists at their mercy. In the worst case, a company can go bankrupt if it cannot pay its creditors. However, a more common (but still costly) situation is when a company has to dilute shareholders at a cheap share price just to keep debt under control. Of course, many companies use debt to finance their growth, without any negative consequences. When we think about a company’s use of debt, we first look at cash and debt together.

See our latest analysis for HF Foods Group

What is the net debt of the HF Foods group?

As you can see below, HF Foods Group had $137.2 million in debt as of September 2021, about the same as the previous year. You can click on the graph for more details. However, since he has a cash reserve of $15.5 million, his net debt is less, at around $121.6 million.

How healthy is the balance sheet of the HF Foods group?

The latest balance sheet data shows that HF ​​Foods Group had liabilities of $97.8 million due within the year, and liabilities of $143.4 million due thereafter. On the other hand, it had liquidities of 15.5 million dollars and 35.1 million dollars of receivables within one year. Thus, its liabilities total $190.6 million more than the combination of its cash and short-term receivables.

This shortfall is not that bad as the HF Foods Group is worth $379.5 million and therefore could probably raise enough capital to shore up its balance sheet, should the need arise. But it is clear that it is essential to examine closely whether it can manage its debt without dilution.

We use two main ratios to inform us about debt to earnings levels. The first is net debt divided by earnings before interest, taxes, depreciation and amortization (EBITDA), while the second is how often its earnings before interest and taxes (EBIT) covers its interest expense (or its interests, for short). Thus, we consider debt to earnings with and without amortization and depreciation expense.

The net debt of the HF Foods group is 3.0 times its EBITDA, which represents a significant but still reasonable leverage effect. However, its interest coverage of 18.9 is very high, suggesting that debt interest charges are currently quite low. We also note that HF ​​Foods Group improved its EBIT from last year’s loss to a positive result of $23 million. There is no doubt that we learn the most about debt from the balance sheet. But it is the earnings of HF Foods Group that will influence the balance sheet in the future. So, when considering debt, it is definitely worth looking at the earnings trend. Click here for an interactive preview.

Finally, a company can only repay its debts with cold hard cash, not with book profits. It is therefore important to check how much of its earnings before interest and taxes (EBIT) converts into actual free cash flow. Last year, HF Foods Group’s free cash flow was 35% of its EBIT, less than we expected. It’s not great when it comes to paying off debt.

Our point of view

Neither the ability of the HF Foods group to manage its debt, on the basis of its EBITDA, nor its level of total liabilities gave us confidence in its ability to take on more debt. But the good news is that it seems to be able to easily cover its interest costs with its EBIT. We think HF Foods Group’s debt makes it a bit risky, after looking at the aforementioned data points together. This isn’t necessarily a bad thing, since leverage can increase return on equity, but it is something to be aware of. The balance sheet is clearly the area to focus on when analyzing debt. However, not all investment risks reside on the balance sheet, far from it. We have identified 3 warning signs with HF Foods Group (at least 1 that cannot be ignored), and understanding them should be part of your investment process.

If you are interested in investing in companies that can generate profits without the burden of debt, then check out this free list of growing companies that have net cash on the balance sheet.

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This Simply Wall St article is general in nature. We provide commentary based on historical data and analyst forecasts only using unbiased methodology and our articles are not intended to be financial advice. It is not a recommendation to buy or sell stocks and does not take into account your objectives or financial situation. Our goal is to bring you targeted long-term analysis based on fundamental data. Note that our analysis may not take into account the latest announcements from price-sensitive companies or qualitative materials. Simply Wall St has no position in the stocks mentioned.