Is Monro (NASDAQ:MNRO) A Risky Investment?

By
Simply Wall St
Published
July 24, 2021
NasdaqGS:MNRO
Source: Shutterstock

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.' 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. Importantly, Monro, Inc. (NASDAQ:MNRO) does carry debt. But the real question is whether this debt is making the company risky.

What Risk Does Debt Bring?

Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. 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. When we examine debt levels, we first consider both cash and debt levels, together.

View our latest analysis for Monro

What Is Monro's Debt?

The image below, which you can click on for greater detail, shows that Monro had debt of US$190.0m at the end of March 2021, a reduction from US$566.4m over a year. However, because it has a cash reserve of US$30.0m, its net debt is less, at about US$160.0m.

debt-equity-history-analysis
NasdaqGS:MNRO Debt to Equity History July 24th 2021

A Look At Monro's Liabilities

The latest balance sheet data shows that Monro had liabilities of US$290.6m due within a year, and liabilities of US$771.5m falling due after that. Offsetting this, it had US$30.0m in cash and US$41.2m in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by US$990.9m.

Monro has a market capitalization of US$2.11b, so it could very likely raise cash to ameliorate its balance sheet, if the need arose. But we definitely want to keep our eyes open to indications that its debt is bringing too much risk.

In order to size up a company's debt relative to its earnings, we calculate its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and its earnings before interest and tax (EBIT) divided by its interest expense (its interest cover). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

While Monro's low debt to EBITDA ratio of 1.1 suggests only modest use of debt, the fact that EBIT only covered the interest expense by 2.6 times last year does give us pause. So we'd recommend keeping a close eye on the impact financing costs are having on the business. Importantly, Monro's EBIT fell a jaw-dropping 33% in the last twelve months. If that earnings trend continues then paying off its debt will be about as easy as herding cats on to a roller coaster. 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 Monro's ability to maintain a healthy balance sheet going forward. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So we always check how much of that EBIT is translated into free cash flow. Over the last three years, Monro recorded free cash flow worth a fulsome 100% of its EBIT, which is stronger than we'd usually expect. That puts it in a very strong position to pay down debt.

Our View

Neither Monro's ability to grow its EBIT nor its interest cover gave us confidence in its ability to take on more debt. But its conversion of EBIT to free cash flow tells a very different story, and suggests some resilience. We think that Monro's debt does make it a bit risky, after considering the aforementioned data points together. Not all risk is bad, as it can boost share price returns if it pays off, but this debt risk is worth keeping in mind. 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 example - Monro has 1 warning sign we think 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. 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.
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