Simply Good Foods (NASDAQ:SMPL) Could Easily Take On More Debt

David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the permanent loss of capital.' 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. We note that The Simply Good Foods Company (NASDAQ:SMPL) does have debt on its balance sheet. But the real question is whether this debt is making the company risky.

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. 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, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest 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.

See our latest analysis for Simply Good Foods

What Is Simply Good Foods's Debt?

The image below, which you can click on for greater detail, shows that at November 2024 Simply Good Foods had debt of US$348.0m, up from US$272.0m in one year. However, it does have US$121.8m in cash offsetting this, leading to net debt of about US$226.2m.

How Healthy Is Simply Good Foods' Balance Sheet?

The latest balance sheet data shows that Simply Good Foods had liabilities of US$105.0m due within a year, and liabilities of US$552.9m falling due after that. On the other hand, it had cash of US$121.8m and US$149.7m worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by US$386.5m.

Of course, Simply Good Foods has a market capitalization of US$3.83b, so these liabilities are probably manageable. 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). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

With net debt sitting at just 0.88 times EBITDA, Simply Good Foods is arguably pretty conservatively geared. And this view is supported by the solid interest coverage, with EBIT coming in at 10.0 times the interest expense over the last year. And we also note warmly that Simply Good Foods grew its EBIT by 14% last year, making its debt load easier to handle. 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 Simply Good Foods can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. During the last three years, Simply Good Foods generated free cash flow amounting to a very robust 80% of its EBIT, more than we'd expect. That puts it in a very strong position to pay down debt.

Our View

The good news is that Simply Good Foods's demonstrated ability to convert EBIT to free cash flow delights us like a fluffy puppy does a toddler. And the good news does not stop there, as its interest cover also supports that impression! Looking at the bigger picture, we think Simply Good Foods's use of debt seems quite reasonable and we're not concerned about it. While debt does bring risk, when used wisely it can also bring a higher return on equity. Another factor that would give us confidence in Simply Good Foods would be if insiders have been buying shares: if you're conscious of that signal too, you can find out instantly by clicking this link.

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.

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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.