Warren Buffett famously said, 'Volatility is far from synonymous with risk.' 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. We note that The Simply Good Foods Company (NASDAQ:SMPL) does have debt on its balance sheet. But is this debt a concern to shareholders?
Why Does Debt Bring Risk?
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. 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. 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.
What Is Simply Good Foods's Net Debt?
As you can see below, Simply Good Foods had US$191.1m of debt, at May 2019, which is about the same the year before. You can click the chart for greater detail. However, its balance sheet shows it holds US$247.6m in cash, so it actually has US$56.5m net cash.
A Look At Simply Good Foods's Liabilities
Zooming in on the latest balance sheet data, we can see that Simply Good Foods had liabilities of US$39.3m due within 12 months and liabilities of US$255.3m due beyond that. Offsetting this, it had US$247.6m in cash and US$42.8m in receivables that were due within 12 months. So these liquid assets roughly match the total liabilities.
This state of affairs indicates that Simply Good Foods's balance sheet looks quite solid, as its total liabilities are just about equal to its liquid assets. So while it's hard to imagine that the US$2.16b company is struggling for cash, we still think it's worth monitoring its balance sheet. Despite its noteworthy liabilities, Simply Good Foods boasts net cash, so it's fair to say it does not have a heavy debt load!
Also positive, Simply Good Foods grew its EBIT by 21% in the last year, and that should make it easier to pay down debt, going forward. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Simply Good Foods 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.
Finally, a company can only pay off debt with cold hard cash, not accounting profits. Simply Good Foods 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. In the last three years, Simply Good Foods's free cash flow amounted to 46% of its EBIT, less than we'd expect. That's not great, when it comes to paying down debt.
While it is always sensible to look at a company's total liabilities, it is very reassuring that Simply Good Foods has US$57m in net cash. And it impressed us with its EBIT growth of 21% over the last year. So we don't have any problem with Simply Good Foods's use of debt. Of course, we wouldn't say no to the extra confidence that we'd gain if we knew that Simply Good Foods insiders have been buying shares: if you're on the same wavelength, you can find out if insiders are buying by clicking this link.
Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.
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If you spot an error that warrants correction, please contact the editor at firstname.lastname@example.org. 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.