Stock Analysis

Is Middleby (NASDAQ:MIDD) A Risky Investment?

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NasdaqGS:MIDD
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Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk.' 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 The Middleby Corporation (NASDAQ:MIDD) makes use of debt. But should shareholders be worried about its use of debt?

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. When we examine debt levels, we first consider both cash and debt levels, together.

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What Is Middleby's Net Debt?

The image below, which you can click on for greater detail, shows that Middleby had debt of US$1.78b at the end of January 2021, a reduction from US$1.90b over a year. However, because it has a cash reserve of US$268.1m, its net debt is less, at about US$1.51b.

debt-equity-history-analysis
NasdaqGS:MIDD Debt to Equity History April 19th 2021

How Healthy Is Middleby's Balance Sheet?

According to the last reported balance sheet, Middleby had liabilities of US$700.3m due within 12 months, and liabilities of US$2.53b due beyond 12 months. On the other hand, it had cash of US$268.1m and US$383.7m worth of receivables due within a year. So its liabilities total US$2.57b more than the combination of its cash and short-term receivables.

This deficit isn't so bad because Middleby is worth US$9.33b, and thus could probably raise enough capital to shore up its balance sheet, if the need arose. However, it is still worthwhile taking a close look at its ability to pay off debt.

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). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

Middleby has a debt to EBITDA ratio of 3.0 and its EBIT covered its interest expense 5.0 times. Taken together this implies that, while we wouldn't want to see debt levels rise, we think it can handle its current leverage. Shareholders should be aware that Middleby's EBIT was down 29% last year. If that decline continues then paying off debt will be harder than selling foie gras at a vegan convention. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Middleby 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 we always check how much of that EBIT is translated into free cash flow. Over the most recent three years, Middleby recorded free cash flow worth 79% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This cold hard cash means it can reduce its debt when it wants to.

Our View

Middleby's EBIT growth rate was a real negative on this analysis, although the other factors we considered cast it in a significantly better light. For example its conversion of EBIT to free cash flow was refreshing. Looking at all the angles mentioned above, it does seem to us that Middleby is a somewhat risky investment as a result of its debt. Not all risk is bad, as it can boost share price returns if it pays off, but this debt risk is worth keeping in mind. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. Case in point: We've spotted 2 warning signs for Middleby you should be aware of.

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.

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What are the risks and opportunities for Middleby?

The Middleby Corporation designs, manufactures, markets, distributes, and services a range of foodservice, food processing, and residential kitchen equipment in the United States, Canada, Asia, Europe, the Middle East, and Latin America.

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Rewards

  • Trading at 18.5% below our estimate of its fair value

  • Earnings are forecast to grow 9.46% per year

Risks

  • Debt is not well covered by operating cash flow

  • Significant insider selling over the past 3 months

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