Does Empire (TSE:EMP.A) Have A Healthy Balance Sheet?

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. We can see that Empire Company Limited (TSE:EMP.A) does use debt in its business. But the real question is whether this debt is making the company risky.

Why Does Debt Bring Risk?

Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. 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. When we think about a company's use of debt, we first look at cash and debt together.

See our latest analysis for Empire

How Much Debt Does Empire Carry?

As you can see below, Empire had CA$1.18b of debt, at May 2022, which is about the same as the year before. You can click the chart for greater detail. On the flip side, it has CA$812.3m in cash leading to net debt of about CA$364.4m.

A Look At Empire's Liabilities

Zooming in on the latest balance sheet data, we can see that Empire had liabilities of CA$4.24b due within 12 months and liabilities of CA$7.22b due beyond that. On the other hand, it had cash of CA$812.3m and CA$681.3m worth of receivables due within a year. So it has liabilities totalling CA$9.97b more than its cash and near-term receivables, combined.

This deficit is considerable relative to its market capitalization of CA$10.2b, so it does suggest shareholders should keep an eye on Empire's use of debt. Should its lenders demand that it shore up the balance sheet, shareholders would likely face severe 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.

While Empire's low debt to EBITDA ratio of 0.21 suggests only modest use of debt, the fact that EBIT only covered the interest expense by 4.7 times last year does give us pause. So we'd recommend keeping a close eye on the impact financing costs are having on the business. We saw Empire grow its EBIT by 3.9% in the last twelve months. That's far from incredible but it is a good thing, when it comes to paying off debt. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately the future profitability of the business will decide if Empire 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 company can only pay off debt with cold hard cash, not accounting profits. So it's worth checking how much of that EBIT is backed by free cash flow. Happily for any shareholders, Empire actually produced more free cash flow than EBIT over the last three years. That sort of strong cash conversion gets us as excited as the crowd when the beat drops at a Daft Punk concert.

Our View

Both Empire's ability to to convert EBIT to free cash flow and its net debt to EBITDA gave us comfort that it can handle its debt. On the other hand, its level of total liabilities makes us a little less comfortable about its debt. When we consider all the elements mentioned above, it seems to us that Empire is managing its debt quite well. Having said that, the load is sufficiently heavy that we would recommend any shareholders keep a close eye on it. We'd be motivated to research the stock further if we found out that Empire 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.

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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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.