Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' 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 note that Noodles & Company (NASDAQ:NDLS) does have debt on its balance sheet. But should shareholders be worried about its use of debt?
What Risk Does Debt Bring?
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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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, 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.
What Is Noodles's Net Debt?
The chart below, which you can click on for greater detail, shows that Noodles had US$42.2m in debt in September 2020; about the same as the year before. On the flip side, it has US$8.62m in cash leading to net debt of about US$33.5m.
How Strong Is Noodles's Balance Sheet?
We can see from the most recent balance sheet that Noodles had liabilities of US$60.9m falling due within a year, and liabilities of US$269.4m due beyond that. Offsetting these obligations, it had cash of US$8.62m as well as receivables valued at US$3.44m due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by US$318.2m.
Given this deficit is actually higher than the company's market capitalization of US$294.6m, we think shareholders really should watch Noodles's debt levels, like a parent watching their child ride a bike for the first time. In the scenario where the company had to clean up its balance sheet quickly, it seems likely shareholders would suffer extensive dilution. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Noodles'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.
In the last year Noodles had a loss before interest and tax, and actually shrunk its revenue by 13%, to US$400m. We would much prefer see growth.
While Noodles's falling revenue is about as heartwarming as a wet blanket, arguably its earnings before interest and tax (EBIT) loss is even less appealing. To be specific the EBIT loss came in at US$8.3m. When we look at that alongside the significant liabilities, we're not particularly confident about the company. It would need to improve its operations quickly for us to be interested in it. It's fair to say the loss of US$21m didn't encourage us either; we'd like to see a profit. And until that time we think this is a risky stock. 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. To that end, you should be aware of the 1 warning sign we've spotted with Noodles .
If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.
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This article by Simply Wall St is general in nature. 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.
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