Howard Marks put it nicely when he said that, rather than worrying about share price volatility, ‘The possibility of permanent loss is the risk I worry about… and every practical investor I know worries about. 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 1-800-FLOWERS.COM, Inc. (NASDAQ:FLWS) makes use of debt. But should shareholders be worried about its use of debt?
When Is Debt Dangerous?
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. 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.
What Is 1-800-FLOWERS.COM’s Net Debt?
The image below, which you can click on for greater detail, shows that 1-800-FLOWERS.COM had debt of US$95.8m at the end of September 2019, a reduction from US$100.4m over a year. On the flip side, it has US$34.2m in cash leading to net debt of about US$61.6m.
How Healthy Is 1-800-FLOWERS.COM’s Balance Sheet?
We can see from the most recent balance sheet that 1-800-FLOWERS.COM had liabilities of US$135.4m falling due within a year, and liabilities of US$200.1m due beyond that. On the other hand, it had cash of US$34.2m and US$36.1m worth of receivables due within a year. So its liabilities total US$265.3m more than the combination of its cash and short-term receivables.
This deficit isn’t so bad because 1-800-FLOWERS.COM is worth US$838.7m, and thus could probably raise enough capital to shore up its balance sheet, if the need arose. But it’s clear that we should definitely closely examine whether it can manage its debt without dilution.
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.
1-800-FLOWERS.COM’s net debt is only 0.79 times its EBITDA. And its EBIT easily covers its interest expense, being 20.3 times the size. So you could argue it is no more threatened by its debt than an elephant is by a mouse. Another good sign is that 1-800-FLOWERS.COM has been able to increase its EBIT by 25% in twelve months, making it easier to pay down debt. There’s no doubt that we learn most about debt from the balance sheet. But it is future earnings, more than anything, that will determine 1-800-FLOWERS.COM’s ability to maintain a healthy balance sheet going forward. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.
Finally, a company can only pay off debt with cold hard cash, not accounting profits. So the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. Over the last three years, 1-800-FLOWERS.COM recorded free cash flow worth a fulsome 87% of its EBIT, which is stronger than we’d usually expect. That positions it well to pay down debt if desirable to do so.
Happily, 1-800-FLOWERS.COM’s impressive interest cover implies it has the upper hand on its debt. And the good news does not stop there, as its conversion of EBIT to free cash flow also supports that impression! Looking at the bigger picture, we think 1-800-FLOWERS.COM’s use of debt seems quite reasonable and we’re not concerned about it. After all, sensible leverage can boost returns on equity. Over time, share prices tend to follow earnings per share, so if you’re interested in 1-800-FLOWERS.COM, you may well want to click here to check an interactive graph of its earnings per share history.
At the end of the day, it’s often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It’s free.
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If you spot an error that warrants correction, please contact the editor at firstname.lastname@example.org. This article by Simply Wall St is general in nature. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. Simply Wall St has no position in the stocks mentioned. Thank you for reading.