Warren Buffett famously said, 'Volatility is far from synonymous with risk.' So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. As with many other companies Olam Group Limited (SGX:VC2) makes use of debt. But the real question is whether this debt is making the company risky.

What Risk Does Debt Bring?

Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. 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.

What Is Olam Group's Net Debt?

The chart below, which you can click on for greater detail, shows that Olam Group had S$15.4b in debt in December 2023; about the same as the year before. On the flip side, it has S$3.63b in cash leading to net debt of about S$11.8b.

How Healthy Is Olam Group's Balance Sheet?

According to the last reported balance sheet, Olam Group had liabilities of S$15.5b due within 12 months, and liabilities of S$10.2b due beyond 12 months. Offsetting these obligations, it had cash of S$3.63b as well as receivables valued at S$3.34b due within 12 months. So its liabilities total S$18.7b more than the combination of its cash and short-term receivables.

This deficit casts a shadow over the S$4.16b company, like a colossus towering over mere mortals. So we'd watch its balance sheet closely, without a doubt. After all, Olam Group would likely require a major re-capitalisation if it had to pay its creditors today.

We measure a company's debt load relative to its earnings power by looking at its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and by calculating how easily its earnings before interest and tax (EBIT) cover its interest expense (interest cover). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

Olam Group shareholders face the double whammy of a high net debt to EBITDA ratio (5.2), and fairly weak interest coverage, since EBIT is just 1.4 times the interest expense. The debt burden here is substantial. The good news is that Olam Group improved its EBIT by 5.3% over the last twelve months, thus gradually reducing its debt levels relative to its earnings. There's no doubt that we learn most about debt from the balance sheet. But it is Olam Group's earnings that will influence how the balance sheet holds up in the future. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So we always check how much of that EBIT is translated into free cash flow. Over the last three years, Olam Group saw substantial negative free cash flow, in total. While that may be a result of expenditure for growth, it does make the debt far more risky.

Our View

To be frank both Olam Group's conversion of EBIT to free cash flow and its track record of staying on top of its total liabilities make us rather uncomfortable with its debt levels. But at least its EBIT growth rate is not so bad. Taking into account all the aforementioned factors, it looks like Olam Group has too much debt. While some investors love that sort of risky play, it's certainly not our cup of tea. 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 4 warning signs for Olam Group (of which 2 are a bit concerning!) 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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This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.