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, John B. Sanfilippo & Son, Inc. (NASDAQ:JBSS) does carry debt. But should shareholders be worried about its use of debt?
Why Does Debt Bring Risk?
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. 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. 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 step when considering a company's debt levels is to consider its cash and debt together.
How Much Debt Does John B. Sanfilippo & Son Carry?
As you can see below, John B. Sanfilippo & Son had US$34.1m of debt at March 2021, down from US$62.1m a year prior. However, it also had US$1.04m in cash, and so its net debt is US$33.0m.
How Healthy Is John B. Sanfilippo & Son's Balance Sheet?
Zooming in on the latest balance sheet data, we can see that John B. Sanfilippo & Son had liabilities of US$106.7m due within 12 months and liabilities of US$54.7m due beyond that. Offsetting this, it had US$1.04m in cash and US$64.5m in receivables that were due within 12 months. So its liabilities total US$95.8m more than the combination of its cash and short-term receivables.
Since publicly traded John B. Sanfilippo & Son shares are worth a total of US$1.06b, it seems unlikely that this level of liabilities would be a major threat. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time.
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). The advantage of this approach is that we take into account both the absolute quantum of debt (with net debt to EBITDA) and the actual interest expenses associated with that debt (with its interest cover ratio).
John B. Sanfilippo & Son's net debt is only 0.35 times its EBITDA. And its EBIT covers its interest expense a whopping 47.9 times over. So you could argue it is no more threatened by its debt than an elephant is by a mouse. John B. Sanfilippo & Son's EBIT was pretty flat over the last year, but that shouldn't be an issue given the it doesn't have a lot of debt. The balance sheet is clearly the area to focus on when you are analysing debt. But it is future earnings, more than anything, that will determine John B. Sanfilippo & Son'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. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. Happily for any shareholders, John B. Sanfilippo & Son actually produced more free cash flow than EBIT over the last three years. That sort of strong cash generation warms our hearts like a puppy in a bumblebee suit.
Happily, John B. Sanfilippo & Son's impressive interest cover implies it has the upper hand on its debt. And that's just the beginning of the good news since its conversion of EBIT to free cash flow is also very heartening. Looking at the bigger picture, we think John B. Sanfilippo & Son's use of debt seems quite reasonable and we're not concerned about it. After all, sensible leverage can boost returns on equity. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. For example - John B. Sanfilippo & Son has 2 warning signs we think you should be aware of.
At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.
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What are the risks and opportunities for John B. Sanfilippo & Son?
Price-To-Earnings ratio (16.2x) is below the Food industry average (17.9x)
Significant insider selling over the past 3 months
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