Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett said “volatility is far from risk.” It’s natural to consider a company’s balance sheet when looking at its level of risk, as debt is often involved when a business collapses. We notice that The producers of Calavo, Inc. (NASDAQ: CVGW) has debt on its balance sheet. But the most important question is: what risk does this debt create?
When is debt a problem?
Debts and other liabilities become risky for a business when it cannot easily meet these obligations, either with free cash flow or by raising capital at an attractive price. If things really go wrong, lenders can take over the business. However, a more common (but still costly) event is when a company has to issue stock at bargain prices, constantly diluting shareholders, just to strengthen its balance sheet. That said, the most common situation is where a business manages its debt reasonably well – and to its own advantage. When we look at debt levels, we first consider both cash and debt levels.
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How much debt do Calavo producers carry?
As you can see below, Calavo Growers had a debt of US $ 42.3 million in April 2021, up from US $ 45.0 million the year before. However, it has $ 5.58 million in cash offsetting that, which leads to net debt of around $ 36.7 million.
How strong is the balance sheet of Calavo producers?
According to the latest published balance sheet, Calavo Growers had a liability of US $ 95.6 million due within 12 months and a liability of US $ 107.0 million due beyond 12 months. In return, he had $ 5.58 million in cash and $ 92.5 million in receivables due within 12 months. As a result, its liabilities exceed the sum of its cash and (short-term) receivables by $ 104.5 million.
Given that Calavo Growers’ listed shares are worth a total of US $ 1.21 billion, it seems unlikely that this level of liabilities is a major threat. But there are enough liabilities that we would certainly recommend that shareholders continue to monitor the balance sheet going forward.
We use two main ratios to tell us about leverage versus earnings levels. The first is net debt divided by earnings before interest, taxes, depreciation, and amortization (EBITDA), while the second is the number of times its profit before interest and taxes (EBIT) covers its interest expense (or its coverage of interest, for short). The advantage of this approach is that we take into account both the absolute amount of debt (with net debt over EBITDA) and the actual interest charges associated with this debt (with its interest coverage rate). ).
Calavo Growers has a low debt to EBITDA ratio of just 0.67. But what’s really cool is that he managed to earn more interest than he paid in the last year. So there is no doubt that this company can go into debt while still being cool as a cucumber. In contrast, Calavo Growers has seen its EBIT fall by 4.3% over the past twelve months. If profits continue to decline at this rate, the company may find it increasingly difficult to manage debt. When analyzing debt levels, the balance sheet is the obvious starting point. But ultimately, the company’s future profitability will decide whether Calavo Growers can strengthen its balance sheet over time. So, if you want to see what the professionals think, you might find this free analyst earnings forecast report interesting.
But our last consideration is also important, because a company cannot pay its debts with paper profits; he needs hard cash. It is therefore worth checking to what extent this EBIT is supported by free cash flow. Over the past three years, Calavo Growers has generated strong free cash flow equivalent to 68% of its EBIT, roughly what we expected. This free cash flow puts the business in a good position to repay debt, if any.
Our point of view
Calavo Growers’ interest coverage suggests he can manage his debt as easily as Cristiano Ronaldo could score a goal against an Under-14 keeper. But, on a darker note, we’re a little concerned about its EBIT growth rate. When we consider the range of factors above, it looks like Calavo Growers is being pretty reasonable with its use of debt. This means that they are taking a bit more risk, in the hope of increasing returns for shareholders. When analyzing debt levels, the balance sheet is the obvious starting point. However, not all investment risks lie on the balance sheet – far from it. For example, we discovered 2 warning signs for Calavo growers which you should know before investing here.
At the end of the day, it’s often best to focus on businesses with no net debt. You can access our special list of these companies (all with a history of profit growth). It’s free.
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