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.' So it seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. Importantly, Potbelly Corporation (NASDAQ:PBPB) does carry debt. 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 common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we examine debt levels, we first consider both cash and debt levels, together.
How Much Debt Does Potbelly Carry?
You can click the graphic below for the historical numbers, but it shows that Potbelly had US$12.8m of debt in March 2021, down from US$39.8m, one year before. However, because it has a cash reserve of US$11.5m, its net debt is less, at about US$1.28m.
How Healthy Is Potbelly's Balance Sheet?
Zooming in on the latest balance sheet data, we can see that Potbelly had liabilities of US$65.0m due within 12 months and liabilities of US$198.7m due beyond that. On the other hand, it had cash of US$11.5m and US$4.64m worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by US$247.6m.
Given this deficit is actually higher than the company's market capitalization of US$192.1m, we think shareholders really should watch Potbelly'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. Potbelly has a very little net debt but plenty of other liabilities weighing it down. 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 Potbelly'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.
Over 12 months, Potbelly made a loss at the EBIT level, and saw its revenue drop to US$282m, which is a fall of 29%. To be frank that doesn't bode well.
While Potbelly'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$57m. 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$21m over the last twelve months. That means it's on the risky side of things. 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. For example, we've discovered 4 warning signs for Potbelly (1 shouldn't be ignored!) that you should be aware of before investing here.
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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What are the risks and opportunities for Potbelly?
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