Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk.' 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. We can see that John B. Sanfilippo & Son, Inc. (NASDAQ:JBSS) does use debt in its business. But is this debt a concern to shareholders?
When Is Debt A Problem?
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. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. When we examine debt levels, we first consider both cash and debt levels, together.
What Is John B. Sanfilippo & Son's Net Debt?
The image below, which you can click on for greater detail, shows that at September 2021 John B. Sanfilippo & Son had debt of US$59.2m, up from US$53.0m in one year. Net debt is about the same, since the it doesn't have much cash.
How Strong Is John B. Sanfilippo & Son's Balance Sheet?
The latest balance sheet data shows that John B. Sanfilippo & Son had liabilities of US$123.8m due within a year, and liabilities of US$55.2m falling due after that. On the other hand, it had cash of US$539.0k and US$71.9m worth of receivables due within a year. So it has liabilities totalling US$106.5m more than its cash and near-term receivables, combined.
Given John B. Sanfilippo & Son has a market capitalization of US$946.6m, it's hard to believe these liabilities pose much threat. But there are sufficient liabilities that we would certainly recommend shareholders continue to monitor the balance sheet, going forward.
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). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.
John B. Sanfilippo & Son's net debt is only 0.57 times its EBITDA. And its EBIT covers its interest expense a whopping 62.5 times over. So you could argue it is no more threatened by its debt than an elephant is by a mouse. Also good is that John B. Sanfilippo & Son grew its EBIT at 14% over the last year, further increasing its ability to manage debt. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately the future profitability of the business will decide if John B. Sanfilippo & Son can strengthen its balance sheet over time. So if you're focused on the future you can check out this free report showing analyst profit forecasts.
Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So it's worth checking how much of that EBIT is backed by free cash flow. Over the last three years, John B. Sanfilippo & Son recorded free cash flow worth a fulsome 81% of its EBIT, which is stronger than we'd usually expect. That puts it in a very strong position to pay down debt.
The good news is that John B. Sanfilippo & Son's demonstrated ability to cover its interest expense with its EBIT delights us like a fluffy puppy does a toddler. And the good news does not stop there, as its conversion of EBIT to free cash flow also supports that impression! Overall, we don't think John B. Sanfilippo & Son is taking any bad risks, as its debt load seems modest. So we're not worried about the use of a little leverage on the balance sheet. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. Be aware that John B. Sanfilippo & Son is showing 2 warning signs in our investment analysis , and 1 of those can't be ignored...
Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.
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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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.