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. Importantly, Ingles Markets, Incorporated (NASDAQ:IMKT.A) does carry debt. But should shareholders be worried about its use of debt?
When Is Debt A Problem?
Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. The first step when considering a company's debt levels is to consider its cash and debt together.
How Much Debt Does Ingles Markets Carry?
You can click the graphic below for the historical numbers, but it shows that Ingles Markets had US$647.8m of debt in March 2021, down from US$842.1m, one year before. Net debt is about the same, since the it doesn't have much cash.
How Strong Is Ingles Markets' Balance Sheet?
Zooming in on the latest balance sheet data, we can see that Ingles Markets had liabilities of US$294.0m due within 12 months and liabilities of US$792.5m due beyond that. On the other hand, it had cash of US$8.86m and US$88.8m worth of receivables due within a year. So its liabilities total US$988.9m more than the combination of its cash and short-term receivables.
This is a mountain of leverage relative to its market capitalization of US$1.13b. Should its lenders demand that it shore up the balance sheet, shareholders would likely face severe dilution.
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.
Ingles Markets has a low net debt to EBITDA ratio of only 1.4. And its EBIT easily covers its interest expense, being 11.0 times the size. So we're pretty relaxed about its super-conservative use of debt. In addition to that, we're happy to report that Ingles Markets has boosted its EBIT by 91%, thus reducing the spectre of future debt repayments. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since Ingles Markets will need earnings to service that debt. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.
But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. During the last three years, Ingles Markets produced sturdy free cash flow equating to 54% of its EBIT, about what we'd expect. This free cash flow puts the company in a good position to pay down debt, when appropriate.
Both Ingles Markets's ability to to grow its EBIT and its interest cover gave us comfort that it can handle its debt. Having said that, its level of total liabilities somewhat sensitizes us to potential future risks to the balance sheet. Considering this range of data points, we think Ingles Markets is in a good position to manage its debt levels. Having said that, the load is sufficiently heavy that we would recommend any shareholders keep a close eye on it. 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. We've identified 2 warning signs with Ingles Markets , and understanding them should be part of your investment process.
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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