Does Rocky Mountain Chocolate Factory (NASDAQ:RMCF) Have A Healthy Balance Sheet?
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 might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. As with many other companies Rocky Mountain Chocolate Factory, Inc. (NASDAQ:RMCF) makes use of debt. But should shareholders be worried about its use of debt?
When Is Debt A Problem?
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. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. 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 Rocky Mountain Chocolate Factory
How Much Debt Does Rocky Mountain Chocolate Factory Carry?
As you can see below, Rocky Mountain Chocolate Factory had US$829.9k of debt at May 2019, down from US$2.20m a year prior. But it also has US$5.90m in cash to offset that, meaning it has US$5.07m net cash.
A Look At Rocky Mountain Chocolate Factory's Liabilities
The latest balance sheet data shows that Rocky Mountain Chocolate Factory had liabilities of US$5.48m due within a year, and liabilities of US$3.45m falling due after that. Offsetting this, it had US$5.90m in cash and US$4.02m in receivables that were due within 12 months. So it can boast US$985.8k more liquid assets than total liabilities.
Having regard to Rocky Mountain Chocolate Factory's size, it seems that its liquid assets are well balanced with its total liabilities. So it's very unlikely that the US$53.7m company is short on cash, but still worth keeping an eye on the balance sheet. Simply put, the fact that Rocky Mountain Chocolate Factory has more cash than debt is arguably a good indication that it can manage its debt safely.
It is just as well that Rocky Mountain Chocolate Factory's load is not too heavy, because its EBIT was down 30% over the last year. When it comes to paying off debt, falling earnings are no more useful than sugary sodas are for your health. The balance sheet is clearly the area to focus on when you are analysing debt. But it is Rocky Mountain Chocolate Factory's earnings that will influence how the balance sheet holds up in the future. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.
Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. Rocky Mountain Chocolate Factory may have net cash on the balance sheet, but it is still interesting to look at how well the business converts its earnings before interest and tax (EBIT) to free cash flow, because that will influence both its need for, and its capacity to manage debt. Over the last three years, Rocky Mountain Chocolate Factory recorded free cash flow worth a fulsome 87% of its EBIT, which is stronger than we'd usually expect. That puts it in a very strong position to pay down debt.
Summing up
While we empathize with investors who find debt concerning, you should keep in mind that Rocky Mountain Chocolate Factory has net cash of US$5.1m, as well as more liquid assets than liabilities. The cherry on top was that in converted 87% of that EBIT to free cash flow, bringing in US$3.7m. So we don't have any problem with Rocky Mountain Chocolate Factory's use of debt. Another positive for shareholders is that it pays dividends. So if you like receiving those dividend payments, check Rocky Mountain Chocolate Factory's dividend history, without delay!
If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.
We aim to bring you long-term focused research analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material.
If you spot an error that warrants correction, please contact the editor at editorial-team@simplywallst.com. 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. Simply Wall St has no position in the stocks mentioned. Thank you for reading.
