Warren Buffett said: “Volatility is far from synonymous with risk”. So it seems like smart money knows that debt – which is usually involved in bankruptcies – is a very important factor, when you assess the level of risk of a business. Like many other companies United Natural Foods, Inc. (NYSE: UNFI) uses debt. But the real question is whether this debt makes the business risky.
Why Does Debt Bring Risk?
Debt helps a business until the business struggles to repay it, either with new capital or with free cash flow. Ultimately, if the company cannot meet its legal debt repayment obligations, shareholders could walk away with nothing. However, a more common (but still painful) scenario is that he has to raise new equity at low cost, thereby constantly diluting shareholders. That said, the most common situation is where a business manages its debt reasonably well – and to its own advantage. The first thing to do when considering how much debt a business uses is to look at its cash flow and debt together.
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What is the debt of United Natural Foods?
You can click on the graph below for historical figures, but it shows United Natural Foods owed US $ 2.41 billion in debt in May 2021, up from US $ 2.70 billion a year earlier. And he doesn’t have a lot of cash, so his net debt is about the same.
A look at the responsibilities of United Natural Foods
According to the latest published balance sheet, United Natural Foods had liabilities of US $ 2.26 billion due within 12 months and liabilities of US $ 3.95 billion due beyond 12 months. In return, he had $ 39.5 million in cash and $ 1.12 billion in receivables due within 12 months. Its liabilities are therefore US $ 5.06 billion more than the combination of its cash and short-term receivables.
This deficit casts a shadow over the $ 2.07 billion company as a colossus towering over mere mortals. So we would be watching its record closely, without a doubt. After all, United Natural Foods would likely need a major recapitalization if it were to pay its creditors today.
We measure a company’s debt load relative to its earning capacity by looking at its net debt divided by its earnings before interest, taxes, depreciation, and amortization (EBITDA) and calculating how easily its earnings before interest and taxes (EBIT) covers its interest costs (interest coverage). Thus, we consider debt versus earnings with and without amortization charges.
United Natural Foods has a debt to EBITDA ratio of 3.2 and its EBIT has covered its interest expense 2.5 times. This suggests that while debt levels are significant, we would stop calling them problematic. On a slightly more positive note, United Natural Foods increased its EBIT to 17% over the past year, further increasing its ability to manage debt. There is no doubt that we learn the most about debt from the balance sheet. But ultimately, the company’s future profitability will decide whether United Natural Foods 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.
Finally, a business can only pay off its debts with hard cash, not with book profits. The logical step is therefore to examine the proportion of this EBIT that corresponds to the actual free cash flow. Over the past three years, United Natural Foods has recorded free cash flow of 60% 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
Reflecting on United Natural Foods’ attempt to stay on top of its total liabilities, we are certainly not enthusiastic. But at least it’s decent enough to increase your EBIT; it’s encouraging. Once we consider all of the above factors together it seems like United Natural Foods debt makes it a bit risky. Some people like this kind of risk, but we are aware of the potential pitfalls, so we would probably prefer him to carry less debt. The balance sheet is clearly the area you need to focus on when analyzing debt. But at the end of the day, every business can contain risks that exist off the balance sheet. These risks can be difficult to spot. Every business has them, and we’ve spotted 4 warning signs for United Natural Foods (of which 1 is of concern!) that you should know about.
If you are interested in investing in companies that can generate profits without the burden of debt, check out this page free list of growing companies that have net cash on the balance sheet.
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