Middleby (NASDAQ:MIDD) Seems To Use Debt Quite Sensibly

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 can see that The Middleby Corporation (NASDAQ:MIDD) does use debt in its business. But is this debt a concern to shareholders?

What Risk Does Debt Bring?

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. Of course, plenty of companies use debt to fund growth, without any negative consequences. The first step when considering a company's debt levels is to consider its cash and debt together.

View our latest analysis for Middleby

What Is Middleby's Net Debt?

The image below, which you can click on for greater detail, shows that at July 2022 Middleby had debt of US$2.70b, up from US$1.85b in one year. However, because it has a cash reserve of US$168.0m, its net debt is less, at about US$2.53b.

How Strong Is Middleby's Balance Sheet?

We can see from the most recent balance sheet that Middleby had liabilities of US$976.4m falling due within a year, and liabilities of US$3.18b due beyond that. Offsetting these obligations, it had cash of US$168.0m as well as receivables valued at US$660.0m due within 12 months. So its liabilities total US$3.33b more than the combination of its cash and short-term receivables.

This deficit isn't so bad because Middleby is worth US$6.84b, 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.

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). 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).

Middleby has net debt to EBITDA of 3.3 suggesting it uses a fair bit of leverage to boost returns. But the high interest coverage of 9.8 suggests it can easily service that debt. We note that Middleby grew its EBIT by 28% in the last year, and that should make it easier to pay down debt, going forward. 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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So it's worth checking how much of that EBIT is backed by free cash flow. During the last three years, Middleby produced sturdy free cash flow equating to 73% of its EBIT, about what we'd expect. This cold hard cash means it can reduce its debt when it wants to.

Our View

Happily, Middleby's impressive EBIT growth rate implies it has the upper hand on its debt. But, on a more sombre note, we are a little concerned by its net debt to EBITDA. When we consider the range of factors above, it looks like Middleby is pretty sensible with its use of debt. That means they are taking on a bit more risk, in the hope of boosting shareholder returns. 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. Be aware that Middleby is showing 2 warning signs in our investment analysis , and 1 of those makes us a bit uncomfortable...

If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.

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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.