Berkshire Hathaway’s Charlie Munger-backed outside fund manager Li Lu is quick to say, “The biggest risk in investing isn’t price volatility, but whether you’re going to suffer a permanent loss of capital “. So it may be obvious that you need to take debt into account when thinking about the risk of a given stock, because too much debt can sink a business. We note that SpartanNash Company (NASDAQ:SPTN) has debt on its balance sheet. But the more important question is: what risk does this debt create?
Why is debt risky?
Debt and other liabilities become risky for a business when it cannot easily meet those obligations, either with free cash flow or by raising capital at an attractive price. If things go really bad, lenders can take over the business. Although not too common, we often see companies in debt permanently diluting their shareholders because lenders force them to raise capital at a ridiculous price. That said, the most common situation is when a company manages its debt reasonably well – and to its own benefit. When we look at debt levels, we first consider cash and debt levels, together.
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How much debt does SpartanNash have?
As you can see below, SpartanNash had $405.7 million in debt as of January 2022, up from $442.8 million the previous year. However, he has $10.7 million in cash to offset this, resulting in a net debt of approximately $395.1 million.
A look at SpartanNash’s responsibilities
We can see from the most recent balance sheet that SpartanNash had liabilities of US$655.8 million due in one year, and liabilities of US$768.1 million due beyond. As compensation for these obligations, it had cash of US$10.7 million and receivables valued at US$361.7 million due within 12 months. Thus, its liabilities outweigh the sum of its cash and (current) receivables of US$1.05 billion.
Given that this deficit is actually greater than the company’s market capitalization of $1.02 billion, we think shareholders really should be watching SpartanNash’s debt levels, like a parent watching their child go shopping. bike for the first time. In the scenario where the company were to quickly clean up its balance sheet, it seems likely that shareholders would suffer significant dilution.
We use two main ratios to inform us about debt to earnings levels. The first is net debt divided by earnings before interest, taxes, depreciation and amortization (EBITDA), while the second is how often its earnings before interest and taxes (EBIT) covers its interest expense (or its interests, for short). In this way, we consider both the absolute amount of debt, as well as the interest rates paid on it.
SpartanNash has net debt worth 2.1x EBITDA, which isn’t too much, but its interest coverage looks a little low, with EBIT at just 6.8x interest expense. . While these numbers don’t alarm us, it’s worth noting that the cost of corporate debt has a real impact. Shareholders should know that SpartanNash’s EBIT fell 26% last year. If this decline continues, it will be more difficult to repay debts than to sell foie gras at a vegan convention. The balance sheet is clearly the area to focus on when analyzing debt. But it’s future earnings, more than anything, that will determine SpartanNash’s ability to maintain a healthy balance sheet in the future. So if you want to see what the professionals think, you might find this free analyst earnings forecast report interesting.
Finally, while the taxman may love accounting profits, lenders only accept cash. We must therefore clearly examine whether this EBIT generates a corresponding free cash flow. Fortunately for all shareholders, SpartanNash has actually produced more free cash flow than EBIT for the past three years. This kind of high cash conversion gets us as excited as the crowd when the beat drops at a Daft Punk concert.
Our point of view
Reflecting on SpartanNash’s attempt to (not) increase its EBIT, we are certainly not enthusiastic. But on the bright side, its conversion from EBIT to free cash flow is a good sign and makes us more optimistic. Looking at the balance sheet and taking all of these factors into account, we think debt makes SpartanNash stock a bit risky. Some people like that kind of risk, but we’re aware of the potential pitfalls, so we’d probably prefer it to take on less debt. The balance sheet is clearly the area to focus on when analyzing debt. But at the end of the day, every business can contain risks that exist outside of the balance sheet. For example, we found 2 warning signs for SpartanNash which you should be aware of before investing here.
In the end, it’s often best to focus on companies that aren’t in debt. You can access our special list of these companies (all with a track record of earnings growth). It’s free.
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This Simply Wall St article is general in nature. We provide commentary based on historical data and analyst forecasts only using unbiased methodology and our articles are not intended to be financial advice. It is not a recommendation to buy or sell stocks and does not take into account your objectives or financial situation. Our goal is to bring you targeted long-term analysis based on fundamental data. Note that our analysis may not take into account the latest announcements from price-sensitive companies or qualitative materials. Simply Wall St has no position in the stocks mentioned.
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