Is Ark Restaurants (NASDAQ:ARKR) Using Debt Sensibly?

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. Importantly, Ark Restaurants Corp. (NASDAQ:ARKR) does carry debt. But the more important question is: how much risk is that debt creating?

When Is Debt Dangerous?

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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 Ark Restaurants

How Much Debt Does Ark Restaurants Carry?

You can click the graphic below for the historical numbers, but it shows that as of October 2020 Ark Restaurants had US$45.1m of debt, an increase on US$26.5m, over one year. However, it does have US$16.9m in cash offsetting this, leading to net debt of about US$28.2m.

A Look At Ark Restaurants' Liabilities

Zooming in on the latest balance sheet data, we can see that Ark Restaurants had liabilities of US$30.1m due within 12 months and liabilities of US$86.0m due beyond that. On the other hand, it had cash of US$16.9m and US$2.12m worth of receivables due within a year. So its liabilities total US$97.2m more than the combination of its cash and short-term receivables.

Given this deficit is actually higher than the company's market capitalization of US$68.9m, we think shareholders really should watch Ark Restaurants's debt levels, like a parent watching their child ride a bike for the first time. Hypothetically, extremely heavy dilution would be required if the company were forced to pay down its liabilities by raising capital at the current share price. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since Ark Restaurants 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.

In the last year Ark Restaurants had a loss before interest and tax, and actually shrunk its revenue by 34%, to US$106m. To be frank that doesn't bode well.

Caveat Emptor

While Ark Restaurants's falling revenue is about as heartwarming as a wet blanket, arguably its earnings before interest and tax (EBIT) loss is even less appealing. Its EBIT loss was a whopping US$7.3m. When we look at that alongside the significant liabilities, we're not particularly confident about the company. We'd want to see some strong near-term improvements before getting too interested in the stock. Not least because it had negative free cash flow of US$7.0m over the last twelve months. So suffice it to say we consider the stock to be risky. 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. Be aware that Ark Restaurants is showing 4 warning signs in our investment analysis , and 2 of those are a bit unpleasant...

When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.

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