Stock Analysis

Maple Leaf Foods (TSE:MFI) Seems To Be Using A Lot Of Debt

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TSX:MFI
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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.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. Importantly, Maple Leaf Foods Inc. (TSE:MFI) does carry debt. But should shareholders be worried about its use of debt?

When Is Debt Dangerous?

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. If things get really bad, the lenders can take control of the business. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. 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 Maple Leaf Foods

What Is Maple Leaf Foods's Debt?

As you can see below, at the end of March 2022, Maple Leaf Foods had CA$1.36b of debt, up from CA$980.4m a year ago. Click the image for more detail. On the flip side, it has CA$66.5m in cash leading to net debt of about CA$1.29b.

debt-equity-history-analysis
TSX:MFI Debt to Equity History July 22nd 2022

How Healthy Is Maple Leaf Foods' Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Maple Leaf Foods had liabilities of CA$663.6m due within 12 months and liabilities of CA$1.80b due beyond that. Offsetting this, it had CA$66.5m in cash and CA$253.1m in receivables that were due within 12 months. So its liabilities total CA$2.14b more than the combination of its cash and short-term receivables.

This is a mountain of leverage relative to its market capitalization of CA$3.27b. 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). 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).

Maple Leaf Foods has a debt to EBITDA ratio of 4.5 and its EBIT covered its interest expense 6.4 times. This suggests that while the debt levels are significant, we'd stop short of calling them problematic. Shareholders should be aware that Maple Leaf Foods's EBIT was down 47% last year. If that earnings trend continues then paying off its debt will be about as easy as herding cats on to a roller coaster. 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 Maple Leaf Foods 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. Over the last three years, Maple Leaf Foods saw substantial negative free cash flow, in total. While that may be a result of expenditure for growth, it does make the debt far more risky.

Our View

On the face of it, Maple Leaf Foods's conversion of EBIT to free cash flow left us tentative about the stock, and its EBIT growth rate was no more enticing than the one empty restaurant on the busiest night of the year. Having said that, its ability to cover its interest expense with its EBIT isn't such a worry. We're quite clear that we consider Maple Leaf Foods to be really rather risky, as a result of its balance sheet health. For this reason we're pretty cautious about the stock, and we think shareholders should keep a close eye on its liquidity. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. For example Maple Leaf Foods has 4 warning signs (and 2 which don't sit too well with us) we think you should know about.

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

Valuation is complex, but we're helping make it simple.

Find out whether Maple Leaf Foods is potentially over or undervalued by checking out our comprehensive analysis, which includes fair value estimates, risks and warnings, dividends, insider transactions and financial health.

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About TSX:MFI

Maple Leaf Foods

Maple Leaf Foods Inc. produces food products in the United States, Canada, Japan, China, and internationally.

The Snowflake is a visual investment summary with the score of each axis being calculated by 6 checks in 5 areas.

Analysis AreaScore (0-6)
Valuation4
Future Growth3
Past Performance0
Financial Health1
Dividends3

Read more about these checks in the individual report sections or in our analysis model.

Good value with moderate growth potential.