These 4 Measures Indicate That Recipe Unlimited (TSE:RECP) Is Using Debt Extensively

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.' 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 Recipe Unlimited Corporation (TSE:RECP) does have debt on its balance sheet. But the more important question is: how much risk is that debt creating?

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. If things get really bad, the lenders can take control of the business. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. When we examine debt levels, we first consider both cash and debt levels, together.

See our latest analysis for Recipe Unlimited

What Is Recipe Unlimited's Net Debt?

As you can see below, Recipe Unlimited had CA$516.0m of debt at September 2021, down from CA$556.8m a year prior. On the flip side, it has CA$37.5m in cash leading to net debt of about CA$478.5m.

How Healthy Is Recipe Unlimited's Balance Sheet?

The latest balance sheet data shows that Recipe Unlimited had liabilities of CA$386.5m due within a year, and liabilities of CA$1.31b falling due after that. On the other hand, it had cash of CA$37.5m and CA$190.8m worth of receivables due within a year. So its liabilities total CA$1.47b more than the combination of its cash and short-term receivables.

Given this deficit is actually higher than the company's market capitalization of CA$1.13b, we think shareholders really should watch Recipe Unlimited's debt levels, like a parent watching their child ride a bike for the first time. Hypothetically, extremely heavy dilution would be required if the company were forced to pay down its liabilities by raising capital at the current share price.

In order to size up a company's debt relative to its earnings, we calculate its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and its earnings before interest and tax (EBIT) divided by its interest expense (its interest cover). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

Recipe Unlimited has a debt to EBITDA ratio of 4.1 and its EBIT covered its interest expense 4.3 times. This suggests that while the debt levels are significant, we'd stop short of calling them problematic. Fortunately, Recipe Unlimited grew its EBIT by 3.2% in the last year, slowly shrinking its debt relative to earnings. 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 Recipe Unlimited can strengthen its balance sheet over time. 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 we always check how much of that EBIT is translated into free cash flow. Happily for any shareholders, Recipe Unlimited actually produced more free cash flow than EBIT over the last three years. There's nothing better than incoming cash when it comes to staying in your lenders' good graces.

Our View

Recipe Unlimited's level of total liabilities and net debt to EBITDA definitely weigh on it, in our esteem. But its conversion of EBIT to free cash flow tells a very different story, and suggests some resilience. Taking the abovementioned factors together we do think Recipe Unlimited's debt poses some risks to the business. While that debt can boost returns, we think the company has enough leverage now. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. To that end, you should learn about the 3 warning signs we've spotted with Recipe Unlimited (including 1 which is potentially serious) .

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.

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.

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