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.’ It’s only natural to consider a company’s balance sheet when you examine how risky it is, since debt is often involved when a business collapses. As with many other companies Cracker Barrel Old Country Store, Inc. (NASDAQ:CBRL) makes use of debt. But should shareholders be worried about its use of debt?
When Is Debt A Problem?
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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. Of course, plenty of companies use debt to fund growth, without any negative consequences. When we examine debt levels, we first consider both cash and debt levels, together.
What Is Cracker Barrel Old Country Store’s Debt?
As you can see below, Cracker Barrel Old Country Store had US$401.7m of debt, at May 2019, which is about the same the year before. You can click the chart for greater detail. However, because it has a cash reserve of US$167.6m, its net debt is less, at about US$234.1m.
A Look At Cracker Barrel Old Country Store’s Liabilities
Zooming in on the latest balance sheet data, we can see that Cracker Barrel Old Country Store had liabilities of US$363.8m due within 12 months and liabilities of US$583.3m due beyond that. On the other hand, it had cash of US$167.6m and US$22.2m worth of receivables due within a year. So it has liabilities totalling US$757.3m more than its cash and near-term receivables, combined.
Given Cracker Barrel Old Country Store has a market capitalization of US$4.14b, it’s hard to believe these liabilities pose much threat. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time.
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.
Cracker Barrel Old Country Store has a low net debt to EBITDA ratio of only 0.60. And its EBIT covers its interest expense a whopping 16.9 times over. So you could argue it is no more threatened by its debt than an elephant is by a mouse. On the other hand, Cracker Barrel Old Country Store saw its EBIT drop by 2.6% in the last twelve months. If earnings continue to decline at that rate the company may have increasing difficulty managing its debt load. There’s no doubt that we learn most about debt from the balance sheet. But ultimately the future profitability of the business will decide if Cracker Barrel Old Country Store can strengthen its balance sheet over time. So if you’re focused on the future you can check out this free report showing analyst profit forecasts.
Finally, a business needs free cash flow to pay off debt; accounting profits just don’t cut it. So the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. During the last three years, Cracker Barrel Old Country Store produced sturdy free cash flow equating to 69% of its EBIT, about what we’d expect. This free cash flow puts the company in a good position to pay down debt, when appropriate.
The good news is that Cracker Barrel Old Country Store’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 EBIT growth rate does undermine this impression a bit. All these things considered, it appears that Cracker Barrel Old Country Store can comfortably handle its current debt levels. Of course, while this leverage can enhance returns on equity, it does bring more risk, so it’s worth keeping an eye on this one. We’d be motivated to research the stock further if we found out that Cracker Barrel Old Country Store insiders have bought shares recently. If you would too, then you’re in luck, since today we’re sharing our list of reported insider transactions for free.
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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If you spot an error that warrants correction, please contact the editor at email@example.com. 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.