Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk. 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, Carrols Restaurant Group, Inc. (NASDAQ:TAST) does carry debt. But should shareholders be worried about its use of debt?
What Risk Does Debt Bring?
Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. 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. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.
How Much Debt Does Carrols Restaurant Group Carry?
You can click the graphic below for the historical numbers, but it shows that as of June 2019 Carrols Restaurant Group had US$439.4m of debt, an increase on US$283.3m, over one year. Net debt is about the same, since the it doesn't have much cash.
How Strong Is Carrols Restaurant Group's Balance Sheet?
Zooming in on the latest balance sheet data, we can see that Carrols Restaurant Group had liabilities of US$134.6m due within 12 months and liabilities of US$1.23b due beyond that. On the other hand, it had cash of US$3.41m and US$13.1m worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by US$1.35b.
This deficit casts a shadow over the US$427.5m company, like a colossus towering over mere mortals. So we'd watch its balance sheet closely, without a doubt At the end of the day, Carrols Restaurant Group would probably need a major re-capitalization if its creditors were to demand repayment.
We use two main ratios to inform us about debt levels relative to earnings. The first is net debt divided by earnings before interest, tax, depreciation, and amortization (EBITDA), while the second is how many times its earnings before interest and tax (EBIT) covers its interest expense (or its interest cover, for short). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.
Carrols Restaurant Group shareholders face the double whammy of a high net debt to EBITDA ratio (5.4), and fairly weak interest coverage, since EBIT is just 0.81 times the interest expense. This means we'd consider it to have a heavy debt load. Even worse, Carrols Restaurant Group saw its EBIT tank 50% over the last 12 months. If earnings keep going like that over the long term, it has a snowball's chance in hell of paying off that debt. The balance sheet is clearly the area to focus on when you are analysing debt. But it is future earnings, more than anything, that will determine Carrols Restaurant Group'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 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. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. Over the last three years, Carrols Restaurant Group saw substantial negative free cash flow, in total. While that may be a result of expenditure for growth, it does make the debt far more risky.
On the face of it, Carrols Restaurant Group's EBIT growth rate left us tentative about the stock, and its level of total liabilities was no more enticing than the one empty restaurant on the busiest night of the year. And even its interest cover fails to inspire much confidence. It looks to us like Carrols Restaurant Group carries a significant balance sheet burden. If you play with fire you risk getting burnt, so we'd probably give this stock a wide berth. Given our concerns about Carrols Restaurant Group's debt levels, it seems only prudent to check if insiders have been ditching the stock.
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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