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. When we think about how risky a business is, we always like to look at its use of debt because debt overload can lead to bankruptcy. We note that Cracker Barrel Old Country Store, Inc. (NASDAQ: CBRL) has debt on its balance sheet. But the real question is whether this debt makes the business risky.
What risk does debt entail?
Debt helps a business until the business struggles to repay it, either with new capital or with free cash flow. An integral part of capitalism is the process of “creative destruction” where bankrupt companies are ruthlessly liquidated by their bankers. However, a more common (but still painful) scenario is that he must raise new equity at low cost, thereby diluting shareholders over the long term. Of course, many companies use debt to finance their growth without negative consequences. The first thing to do when considering how much debt a business uses is to look at its cash flow and debt together.
See our latest review for Cracker Barrel Old Country Store
How much debt does the Cracker Barrel Old Country store carry?
As you can see below, Cracker Barrel Old Country Store had a debt of US $ 632.8 million in April 2021, up from US $ 966.7 million the year before. However, given that it has a cash reserve of $ 384.6 million, its net debt is less, at around $ 248.3 million.
How strong is Cracker Barrel Old Country Store’s balance sheet?
Zooming in on the latest balance sheet data, we can see that Cracker Barrel Old Country Store had a liability of US $ 449.0 million owed within 12 months and a liability of US $ 1.55 billion owed beyond that. In return, he had $ 384.6 million in cash and $ 54.6 million in receivables due within 12 months. As a result, its liabilities exceed the sum of its cash and (short-term) receivables by $ 1.56 billion.
Cracker Barrel Old Country Store has a market cap of US $ 3.26 billion, so it could most likely raise funds to improve its balance sheet, should the need arise. However, it is always worth taking a close look at your ability to repay your debt.
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.
Given that net debt is only 1.4 times EBITDA, it is first surprising to see that Cracker Barrel Old Country Store’s EBIT has low interest coverage of 1.6 times. So one way or another, it’s clear that debt levels are not trivial. Shareholders should know that Cracker Barrel Old Country Store’s EBIT fell 60% last year. If this decline continues, then it will be more difficult to pay off the debt than to sell foie gras at a vegan convention. When analyzing debt levels, the balance sheet is the obvious starting point. But it is future profits, more than anything, that will determine Cracker Barrel Old Country Store’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 analyst earnings forecast report interesting.
Finally, a business can only pay off its debts with hard cash, not with book profits. We therefore always check how much of this EBIT is converted into free cash flow. Over the past three years, Cracker Barrel Old Country Store has recorded free cash flow of 62% 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
To be frank, Cracker Barrel Old Country Store’s interest coverage and track record of (not) growing its EBIT makes us rather uncomfortable with its debt levels. But at least it’s pretty decent to convert EBIT into free cash flow; it’s encouraging. Looking at the balance sheet and taking all of these factors into account, we think debt is making Cracker Barrel Old Country Store stock a bit risky. This isn’t necessarily a bad thing, but we would generally feel more comfortable with less leverage. There is no doubt that we learn the most about debt from the balance sheet. However, not all investment risks lie on the balance sheet – far from it. For example, we have identified 4 warning signs for Cracker Barrel Old Country Store (3 cannot be ignored) you must be aware.
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.
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This Simply Wall St article is general in nature. We provide commentary based on historical data and analyst forecasts using only unbiased methodology and our articles are not intended to be financial advice. 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.
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