Maple Leaf Foods (TSE:MFI) takes some risk with its use of debt
David Iben said it well when he said: “Volatility is not a risk that interests us. What matters to us is to avoid the permanent loss of capital. So it seems smart money knows that debt – which is usually involved in bankruptcies – is a very important factor when you’re assessing a company’s risk. Like many other companies Maple Leaf Foods Inc. (TSE:IMF) uses debt. But does this debt worry shareholders?
When is debt a problem?
Generally speaking, debt only becomes a real problem when a company cannot easily repay it, either by raising capital or with its own cash flow. Ultimately, if the company cannot meet its legal debt repayment obligations, shareholders could walk away with nothing. Although not too common, we often see companies in debt permanently diluting their shareholders because lenders force them to raise capital at a ridiculous price. Of course, the advantage of debt is that it often represents cheap capital, especially when it replaces dilution in a business with the ability to reinvest at high rates of return. The first thing to do when considering how much debt a business has is to look at its cash and debt together.
Check out our latest analysis for Maple Leaf Foods
What is Maple Leaf Foods net debt?
The image below, which you can click on for more details, shows that in December 2021, Maple Leaf Foods had a debt of 1.27 billion Canadian dollars, compared to 745.9 million Canadian dollars in one year . However, he also had C$162.0 million in cash, so his net debt is C$1.11 billion.
How healthy is Maple Leaf Foods’ balance sheet?
The latest balance sheet data shows that Maple Leaf Foods had liabilities of C$668.7 million due within one year, and liabilities of C$1.68 billion falling due thereafter. In compensation for these obligations, it had cash of 162.0 million Canadian dollars as well as receivables valued at 202.2 million Canadian dollars maturing within 12 months. Thus, its liabilities outweigh the sum of its cash and (current) receivables of C$1.99 billion.
While that might sound like a lot, it’s not that bad since Maple Leaf Foods has a market capitalization of C$3.70 billion, so it could likely bolster its balance sheet by raising capital if needed. But we definitely want to keep our eyes peeled for indications that its debt is too risky.
In order to assess a company’s debt relative to its earnings, we calculate its net debt divided by its earnings before interest, taxes, depreciation and amortization (EBITDA) and its earnings before interest and taxes (EBIT) divided by its expenses. interest (its interest coverage). Thus, we consider debt to earnings with and without amortization and depreciation expense.
Maple Leaf Foods has a net debt to EBITDA ratio of 3.4, suggesting it uses good leverage to boost returns. But the high interest coverage of 9.5 suggests it can easily repay that debt. Unfortunately, Maple Leaf Foods has seen its EBIT drop by 7.5% over the past twelve months. If profits continue to fall, managing that debt will be as difficult as delivering hot soup on a unicycle. There is no doubt that we learn the most about debt from the balance sheet. But future earnings, more than anything, will determine Maple Leaf Foods’ ability to maintain a healthy balance sheet in the future. So if you want to see what the professionals think, you might find this free analyst earnings forecast report interesting.
Finally, while the taxman may love accounting profits, lenders only accept cash. We therefore always check how much of this EBIT is converted into free cash flow. Over the past three years, Maple Leaf Foods has spent a lot of money. While this may be the result of spending for growth, it makes debt much riskier.
Our point of view
Reflecting on Maple Leaf Foods’ attempt to convert EBIT to free cash flow, we are certainly not enthusiastic. But at least it’s decent enough to cover its interest costs with its EBIT; it’s encouraging. Overall, we think it’s fair to say that Maple Leaf Foods is sufficiently leveraged that there are real risks around the balance sheet. If all goes well, this should boost returns, but on the other hand, the risk of permanent capital loss is increased by debt. The balance sheet is clearly the area to focus on when analyzing debt. However, not all investment risks reside on the balance sheet, far from it. For example, we have identified 2 warning signs for Maple Leaf Foods of which you should be aware.
If you are interested in investing in companies that can generate profits without the burden of debt, then check out this free list of growing companies that have net cash on the balance sheet.
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This Simply Wall St article is general in nature. We provide commentary based on historical data and analyst forecasts only using unbiased methodology and our articles are not intended to be financial advice. It is not a recommendation to buy or sell stocks and does not take into account your objectives or financial situation. Our goal is to bring you targeted long-term analysis based on fundamental data. Note that our analysis may not take into account the latest announcements from price-sensitive companies or qualitative materials. Simply Wall St has no position in the stocks mentioned.