Potbelly (NASDAQ:PBPB) Seems To Use Debt Quite Sensibly

Warren Buffett famously said, '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. We can see that Potbelly Corporation (NASDAQ:PBPB) does use debt in its business. But is this debt a concern to shareholders?

When Is Debt Dangerous?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth 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.

Check out our latest analysis for Potbelly

How Much Debt Does Potbelly Carry?

The image below, which you can click on for greater detail, shows that Potbelly had debt of US$5.00m at the end of March 2024, a reduction from US$22.5m over a year. However, it does have US$12.7m in cash offsetting this, leading to net cash of US$7.72m.

How Healthy Is Potbelly's Balance Sheet?

We can see from the most recent balance sheet that Potbelly had liabilities of US$67.4m falling due within a year, and liabilities of US$146.4m due beyond that. Offsetting these obligations, it had cash of US$12.7m as well as receivables valued at US$8.38m due within 12 months. So it has liabilities totalling US$192.7m more than its cash and near-term receivables, combined.

This is a mountain of leverage relative to its market capitalization of US$233.7m. Should its lenders demand that it shore up the balance sheet, shareholders would likely face severe dilution. Despite its noteworthy liabilities, Potbelly boasts net cash, so it's fair to say it does not have a heavy debt load!

It is well worth noting that Potbelly's EBIT shot up like bamboo after rain, gaining 67% in the last twelve months. That'll make it easier to manage its debt. When analysing debt levels, the balance sheet is the obvious place to start. 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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. While Potbelly has net cash on its balance sheet, it's still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. During the last two years, Potbelly produced sturdy free cash flow equating to 58% of its EBIT, about what we'd expect. This cold hard cash means it can reduce its debt when it wants to.

Summing Up

Although Potbelly's balance sheet isn't particularly strong, due to the total liabilities, it is clearly positive to see that it has net cash of US$7.72m. And we liked the look of last year's 67% year-on-year EBIT growth. So we are not troubled with Potbelly's debt use. 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. For instance, we've identified 3 warning signs for Potbelly that you should be aware of.

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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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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team@simplywallst.com