Here’s Why Wendy’s (NASDAQ: WEN) Can Responsibly Manage Debt
Warren Buffett said: “Volatility is far from synonymous with risk”. When we think about how risky a business is, we always like to look at its use of debt because debt overload can lead to bankruptcy. We can see that Wendy’s company (NASDAQ: WEN) uses debt in its business. But should shareholders be worried about its use of debt?
When is debt dangerous?
Debts and other liabilities become risky for a business when it cannot easily meet these obligations, either with free cash flow or by raising capital at an attractive price. An integral part of capitalism is the process of “creative destruction” where bankrupt companies are ruthlessly liquidated by their bankers. However, a more common (but still costly) situation is where a company has to dilute its shareholders at a cheap share price just to get its debt under control. By replacing dilution, however, debt can be a very good tool for companies that need capital to invest in growth at high rates of return. When we look at debt levels, we first consider both liquidity and debt levels.
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What is Wendy’s debt?
The graph below, which you can click for more details, shows that Wendy’s had $ 2.41 billion in debt as of July 2021; about the same as the year before. However, it has US $ 568.1 million in cash offsetting this, which leads to net debt of around US $ 1.84 billion.
How strong is Wendy’s balance sheet?
We can see from the most recent balance sheet that Wendy’s had liabilities of US $ 372.8 million due within one year and liabilities of US $ 4.22 billion due beyond. On the other hand, he had $ 568.1 million in cash and $ 165.7 million in receivables due within one year. It therefore has liabilities totaling US $ 3.86 billion more than its cash and short-term receivables combined.
This deficit is sizable compared to its market capitalization of US $ 4.97 billion, so he suggests shareholders keep an eye on Wendy’s use of debt. If its lenders asked it to consolidate the balance sheet, shareholders would likely face serious dilution.
In order to measure a company’s debt relative to its profits, we calculate its net debt divided by its earnings before interest, taxes, depreciation and amortization (EBITDA) and its profit before interest and taxes (EBIT) divided by its interest. debtors (its interest coverage). In this way, we consider both the absolute amount of debt, as well as the interest rates paid on it.
Wendy’s debt is 3.8 times its EBITDA, and its EBIT covers its interest expense 3.0 times as much. Overall, this implies that while we wouldn’t like to see debt levels rise, we believe it can handle its current leverage. Looking on the bright side, Wendy’s has increased its EBIT by a silky 45% over the past year. Like the milk of human kindness, this type of growth increases resilience, making the business more capable of handling debt. The balance sheet is clearly the area to focus on when analyzing debt. But it is future earnings, more than anything, that will determine Wendy’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 analyst earnings forecast report interesting.
Finally, a business can only repay its debts with hard cash, not with book profits. It is therefore worth checking to what extent this EBIT is supported by free cash flow. Over the past three years, Wendy’s has recorded free cash flow of 67% of its EBIT, which is close to normal given that free cash flow excludes interest and taxes. This hard cash allows him to reduce his debt whenever he wants.
Our point of view
As for the balance sheet, the bright spot for Wendy’s was the fact that it seems able to increase its EBIT with confidence. But the other factors we noted above weren’t so encouraging. For example, it looks like he has to struggle a bit to cover his interest costs with his EBIT. Looking at all of this data, we feel a little cautious about Wendy’s debt levels. While debt has its advantage in terms of potential higher returns, we think shareholders should definitely consider how leverage levels might make the stock riskier. The balance sheet is clearly the area to focus on when analyzing debt. However, not all investment risks lie on the balance sheet – far from it. For example, Wendy’s has 2 warning signs (and 1 which is a bit rude) we think you should be aware of.
At the end of the day, it’s often best to focus on businesses with no net debt. You can access our special list of these companies (all with a history of profit growth). It’s free.
This Simply Wall St article is general in nature. We provide commentary based on historical data and analyst forecasts using only unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell shares and does not take into account your goals or your financial situation. Our aim is to bring you long-term, targeted analysis based on fundamental data. Note that our analysis may not take into account the latest announcements from price sensitive companies or qualitative material. Simply Wall St has no position in any of the stocks mentioned.
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