Is Chefs' Warehouse (NASDAQ:CHEF) Using Too Much Debt?

Warren Buffett famously said, '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. We can see that The Chefs' Warehouse, Inc. (NASDAQ:CHEF) does use debt in its business. But the more important question is: how much risk is that debt creating?

What Risk Does Debt Bring?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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. 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.

View our latest analysis for Chefs' Warehouse

What Is Chefs' Warehouse's Debt?

The chart below, which you can click on for greater detail, shows that Chefs' Warehouse had US$680.6m in debt in September 2024; about the same as the year before. However, because it has a cash reserve of US$50.7m, its net debt is less, at about US$629.9m.

How Healthy Is Chefs' Warehouse's Balance Sheet?

According to the last reported balance sheet, Chefs' Warehouse had liabilities of US$429.1m due within 12 months, and liabilities of US$864.2m due beyond 12 months. Offsetting these obligations, it had cash of US$50.7m as well as receivables valued at US$360.0m due within 12 months. So its liabilities total US$882.6m more than the combination of its cash and short-term receivables.

While this might seem like a lot, it is not so bad since Chefs' Warehouse has a market capitalization of US$2.14b, and so it could probably strengthen its balance sheet by raising capital if it needed to. But we definitely want to keep our eyes open to indications that its debt is bringing too much risk.

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). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

While we wouldn't worry about Chefs' Warehouse's net debt to EBITDA ratio of 3.5, we think its super-low interest cover of 2.5 times is a sign of high leverage. So shareholders should probably be aware that interest expenses appear to have really impacted the business lately. However, one redeeming factor is that Chefs' Warehouse grew its EBIT at 17% over the last 12 months, boosting its ability to handle its debt. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Chefs' Warehouse's ability to maintain a healthy balance sheet going forward. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So we always check how much of that EBIT is translated into free cash flow. In the last three years, Chefs' Warehouse basically broke even on a free cash flow basis. While many companies do operate at break-even, we prefer see substantial free cash flow, especially if a it already has dead.

Our View

While Chefs' Warehouse's conversion of EBIT to free cash flow makes us cautious about it, its track record of covering its interest expense with its EBIT is no better. At least its EBIT growth rate gives us reason to be optimistic. Taking the abovementioned factors together we do think Chefs' Warehouse'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. But ultimately, every company can contain risks that exist outside of the balance sheet. We've identified 2 warning signs with Chefs' Warehouse (at least 1 which shouldn't be ignored) , and understanding them should be part of your investment process.

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.