We Think Performance Food Group (NYSE:PFGC) Can Stay On Top Of Its Debt

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. As with many other companies Performance Food Group Company (NYSE:PFGC) makes use of debt. But should shareholders be worried about its use of debt?

Why Does Debt Bring Risk?

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. 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, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

View our latest analysis for Performance Food Group

What Is Performance Food Group's Net Debt?

As you can see below, Performance Food Group had US$3.71b of debt, at September 2023, which is about the same as the year before. You can click the chart for greater detail. And it doesn't have much cash, so its net debt is about the same.

How Healthy Is Performance Food Group's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Performance Food Group had liabilities of US$3.48b due within 12 months and liabilities of US$5.60b due beyond that. On the other hand, it had cash of US$7.80m and US$2.40b worth of receivables due within a year. So its liabilities total US$6.67b more than the combination of its cash and short-term receivables.

This is a mountain of leverage even relative to its gargantuan market capitalization of US$10.3b. This suggests shareholders would be heavily diluted if the company needed to shore up its balance sheet in a hurry.

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.

Performance Food Group's debt is 2.9 times its EBITDA, and its EBIT cover its interest expense 3.5 times over. This suggests that while the debt levels are significant, we'd stop short of calling them problematic. Looking on the bright side, Performance Food Group boosted its EBIT by a silky 69% in the last year. Like the milk of human kindness that sort of growth increases resilience, making the company more capable of managing debt. There's no doubt that we learn most about debt from the balance sheet. But it is future earnings, more than anything, that will determine Performance Food Group's ability to maintain a healthy balance sheet going forward. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. In the last three years, Performance Food Group's free cash flow amounted to 46% of its EBIT, less than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.

Our View

On our analysis Performance Food Group's EBIT growth rate should signal that it won't have too much trouble with its debt. But the other factors we noted above weren't so encouraging. For example, its interest cover makes us a little nervous about its debt. Looking at all this data makes us feel a little cautious about Performance Food Group's debt levels. While we appreciate debt can enhance returns on equity, we'd suggest that shareholders keep close watch on its debt levels, lest they increase. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. Case in point: We've spotted 1 warning sign for Performance Food Group you should be aware of.

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.