Legendary fund manager Li Lu (who Charlie Munger supported) once said, “The biggest risk in investing is not price volatility, but the possibility that you will suffer a permanent loss of capital. It is only natural to consider a company’s balance sheet when looking at its level of risk, as debt is often involved when a business collapses. Like many other companies The Middleby Company (NASDAQ: MIDD) uses debt. But should shareholders be concerned about its use of debt?
What risk does debt entail?
Debt is a tool to help businesses grow, but if a business is unable to repay its lenders, then it exists at their mercy. If things really go wrong, lenders can take over the business. However, a more common (but still costly) situation is where a company has to dilute its shareholders at a cheap share price just to get its debt under control. By replacing dilution, however, debt can be a very good tool for companies that need capital to invest in growth at high rates of return. The first step in examining a company’s debt levels is to consider its cash flow and debt together.
See our latest analysis for Middleby
What is Middleby’s debt?
You can click on the chart below for historical numbers, but it shows Middleby had $ 1.78 billion in debt in April 2021, down from $ 2.26 billion a year earlier. However, given that it has a cash reserve of $ 309.3 million, its net debt is less, at around $ 1.47 billion.
How strong is Middleby’s balance sheet?
According to the latest published balance sheet, Middleby had a liability of US $ 714.4 million due within 12 months and a liability of US $ 2.58 billion due beyond 12 months. On the other hand, it had US $ 309.3 million in cash and US $ 446.8 million in receivables due within a year. It therefore has liabilities totaling $ 2.54 billion more than its cash and short-term receivables combined.
While that might sound like a lot, it’s not so bad since Middleby has a massive market cap of US $ 10.3 billion, and could therefore likely strengthen its balance sheet by raising capital if needed. But it is clear that it is absolutely necessary to take a close look whether it can manage its debt without dilution.
We use two main ratios to inform us about the levels of debt compared to earnings. 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). Thus, we consider debt versus earnings with and without amortization charges.
Middleby’s debt is 2.9 times its EBITDA and its EBIT covers its interest expense 5.1 times. This suggests that while debt levels are significant, we would stop calling them problematic. Shareholders should know that Middleby’s EBIT fell 26% last year. If this earnings trend continues, paying off debt will be about as easy as driving cats on a roller coaster. The balance sheet is clearly the area you need to focus on when analyzing debt. But it is future earnings, more than anything, that will determine Middleby’s ability to maintain a healthy balance sheet going forward. So if you are focused on the future you can check this out free report showing analysts’ earnings forecasts.
Finally, a business needs free cash flow to pay off debts; accounting profits are not enough. We therefore always check how much of this EBIT is converted into free cash flow. Over the past three years, Middleby has recorded free cash flow of 79% of its EBIT, which is close to normal given that free cash flow excludes interest and taxes. This hard cash allows him to reduce his debt whenever he wants.
Our point of view
From what we’ve seen, Middleby doesn’t find it easy, given its rate of EBIT growth, but the other factors we’ve taken into account give us cause for optimism. There is no doubt that its ability to convert EBIT into free cash flow is quite fast. Looking at all of this data, we feel a little cautious about Middleby’s debt levels. While debt has its advantage in terms of potential higher returns, we believe shareholders should definitely consider how leverage levels might make the stock riskier. There is no doubt that we learn the most about debt from the balance sheet. But at the end of the day, every business can contain risks that exist off the balance sheet. Know that Middleby shows 1 warning sign in our investment analysis , you must know…
If, after all of this, you’re more interested in a fast-growing company with a strong balance sheet, take a quick look at our list of cash net growth stocks.
If you are looking to trade Middleby, open an account with the cheapest platform * approved by professionals, Interactive brokers. Their clients from more than 200 countries and territories trade stocks, options, futures, currencies, bonds and funds around the world from a single integrated account.
This Simply Wall St article is general in nature. It does not constitute a recommendation to buy or sell shares and does not take into account your goals or your financial situation. Our aim is to bring you long-term, targeted analysis based on fundamental data. Note that our analysis may not take into account the latest announcements from price sensitive companies or qualitative documents. Simply Wall St has no position in the mentioned stocks.
*Interactive Brokers Ranked Least Expensive Broker By StockBrokers.com Online Annual Review 2020
Do you have any feedback on this item? Are you worried about the content? Get in touch with us directly. You can also send an email to the editorial team (at) simplywallst.com.