Legendary fund manager Li Lu (whom Charlie Munger once backed) once said, “The greatest risk in investing is not price volatility, but whether you will suffer a permanent loss of capital. It’s natural to consider a company’s balance sheet when looking at its riskiness, as debt is often involved when a company fails. Mostly, Noodles & Company (NASDAQ:NDLS) is in debt. But the real question is whether this debt makes the business risky.
What risk does debt carry?
Debt and other liabilities become risky for a business when it cannot easily meet those obligations, either with free cash flow or by raising capital at an attractive price. Ultimately, if the company cannot meet its legal debt repayment obligations, shareholders could walk away with nothing. However, a more usual (but still expensive) situation is when a company has to dilute shareholders at a cheap share price just to keep debt under control. By replacing dilution, however, debt can be a great tool for companies that need capital to invest in growth 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.
See our latest analysis for noodles
How many debts do the noodles carry?
You can click on the chart below for historical numbers, but it shows Noodles had $21.0 million in debt in December 2021, up from $42.1 million a year prior. However, he also had $2.26 million in cash, so his net debt is $18.7 million.
How healthy is Noodles’ balance sheet?
We can see from the most recent balance sheet that Noodles had liabilities of $76.6 million due in one year, and liabilities of $227.2 million beyond. In return, he had $2.26 million in cash and $4.07 million in receivables due within 12 months. Thus, its liabilities total $297.5 million more than the combination of its cash and short-term receivables.
This shortfall is sizable relative to its market capitalization of US$303.5 million, so he suggests shareholders watch Noodles’ use of debt. If its lenders asked it to shore up its balance sheet, shareholders would likely face significant dilution.
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.
Looking at its net debt to EBITDA of 0.55 and its interest coverage of 5.5 times, it seems to us that Noodles is probably using debt quite sensibly. But the interest payments are certainly enough to make us think about the affordability of its debt. We also note that Noodles improved its EBIT from last year’s loss to a positive result of US$12 million. 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 Noodles 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, while the taxman may love accounting profits, lenders only accept cash. It is therefore worth checking how much of earnings before interest and tax (EBIT) is supported by free cash flow. Fortunately for all shareholders, Noodles has actually produced more free cash flow than EBIT over the past year. This kind of strong cash generation warms our hearts like a puppy in a bumblebee suit.
Our point of view
Based on our analysis, Noodles’ conversion of EBIT to free cash flow should indicate that it won’t have too many debt problems. But the other factors we noted above weren’t so encouraging. For example, his level of total liabilities makes us a little nervous about his debt. When we consider all the factors mentioned above, we feel a bit cautious about Noodles’ use of debt. While debt has its upside in higher potential returns, we think shareholders should certainly consider how debt levels might make the stock more risky. The balance sheet is clearly the area to focus on when analyzing debt. But at the end of the day, every business can contain risks that exist outside of the balance sheet. We have identified 3 warning signs with Noodles, and understanding them should be part of your investment process.
In the end, sometimes it’s easier to focus on companies that don’t even need to take on debt. Readers can access a list of growth stocks with no net debt 100% freeat present.
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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.