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Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a 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. Importantly, Darden Restaurants, Inc. (NYSE:DRI) does carry debt. But should shareholders be worried about its use of debt?
What Risk Does Debt Bring?
Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. If things get really bad, the lenders can take control of the business. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. The first step when considering a company's debt levels is to consider its cash and debt together.
What Is Darden Restaurants's Net Debt?
You can click the graphic below for the historical numbers, but it shows that Darden Restaurants had US$930.0m of debt in May 2021, down from US$1.20b, one year before. But it also has US$1.21b in cash to offset that, meaning it has US$284.7m net cash.
How Healthy Is Darden Restaurants' Balance Sheet?
According to the last reported balance sheet, Darden Restaurants had liabilities of US$1.85b due within 12 months, and liabilities of US$5.99b due beyond 12 months. Offsetting these obligations, it had cash of US$1.21b as well as receivables valued at US$65.2m due within 12 months. So its liabilities total US$6.56b more than the combination of its cash and short-term receivables.
While this might seem like a lot, it is not so bad since Darden Restaurants has a huge market capitalization of US$19.4b, and so it could probably strengthen its balance sheet by raising capital if it needed to. However, it is still worthwhile taking a close look at its ability to pay off debt. Despite its noteworthy liabilities, Darden Restaurants boasts net cash, so it's fair to say it does not have a heavy debt load!
In addition to that, we're happy to report that Darden Restaurants has boosted its EBIT by 48%, thus reducing the spectre of future debt repayments. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Darden Restaurants 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.
But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. While Darden Restaurants has net cash on its balance sheet, it's still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. Over the last three years, Darden Restaurants recorded free cash flow worth a fulsome 99% of its EBIT, which is stronger than we'd usually expect. That puts it in a very strong position to pay down debt.
While Darden Restaurants does have more liabilities than liquid assets, it also has net cash of US$284.7m. And it impressed us with free cash flow of US$924m, being 99% of its EBIT. So is Darden Restaurants's debt a risk? It doesn't seem so to us. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. These risks can be hard to spot. Every company has them, and we've spotted 1 warning sign for Darden Restaurants you should know about.
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.
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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