Warren Buffett famously said, 'Volatility is far from synonymous with risk.' So it seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. We note that MTY Food Group Inc. (TSE:MTY) does have debt on its balance sheet. But is this debt a concern to shareholders?
Why Does Debt Bring Risk?
Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. If things get really bad, the lenders can take control of the business. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. The first step when considering a company's debt levels is to consider its cash and debt together.
What Is MTY Food Group's Debt?
The image below, which you can click on for greater detail, shows that MTY Food Group had debt of CA$362.2m at the end of February 2022, a reduction from CA$441.4m over a year. However, it also had CA$52.5m in cash, and so its net debt is CA$309.7m.
How Strong Is MTY Food Group's Balance Sheet?
According to the last reported balance sheet, MTY Food Group had liabilities of CA$381.0m due within 12 months, and liabilities of CA$874.6m due beyond 12 months. Offsetting this, it had CA$52.5m in cash and CA$154.9m in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by CA$1.05b.
This deficit is considerable relative to its market capitalization of CA$1.44b, so it does suggest shareholders should keep an eye on MTY Food Group's use of debt. Should its lenders demand that it shore up the balance sheet, shareholders would likely face severe dilution.
We use two main ratios to inform us about debt levels relative to earnings. The first is net debt divided by earnings before interest, tax, depreciation, and amortization (EBITDA), while the second is how many times its earnings before interest and tax (EBIT) covers its interest expense (or its interest cover, for short). The advantage of this approach is that we take into account both the absolute quantum of debt (with net debt to EBITDA) and the actual interest expenses associated with that debt (with its interest cover ratio).
We'd say that MTY Food Group's moderate net debt to EBITDA ratio ( being 2.0), indicates prudence when it comes to debt. And its commanding EBIT of 12.5 times its interest expense, implies the debt load is as light as a peacock feather. It is well worth noting that MTY Food Group's EBIT shot up like bamboo after rain, gaining 57% in the last twelve months. That'll make it easier to manage its debt. 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 MTY Food Group 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, MTY Food Group 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.
The good news is that MTY Food Group's demonstrated ability to cover its interest expense with its EBIT delights us like a fluffy puppy does a toddler. But, on a more sombre note, we are a little concerned by its level of total liabilities. Taking all this data into account, it seems to us that MTY Food Group takes a pretty sensible approach to debt. That means they are taking on a bit more risk, in the hope of boosting shareholder returns. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. For example MTY Food Group has 2 warning signs (and 1 which is significant) we think 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.