Does the Franchise Group (NASDAQ: FRG) have a healthy balance sheet?
David Iben put it well when he said: “Volatility is not a risk that is close to our hearts. What matters to us is to avoid the permanent loss of capital. ‘ So it can be obvious that you need to consider debt, when you think about how risky a given stock is because too much debt can sink a business. We can see that Franchise Group, Inc. (NASDAQ: FRG) uses debt in its business. But does this debt worry shareholders?
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. In the worst case scenario, a business can go bankrupt if it cannot pay its creditors. However, a more common (but still costly) event is when a company has to issue stock at bargain prices, constantly diluting shareholders, just to strengthen its balance sheet. That said, the most common situation is where a business manages its debt reasonably well – and to its own advantage. When we think of a business’s use of debt, we first look at cash flow and debt together.
What is the debt of the Franchise group?
You can click on the graph below for historical figures, but it shows that as of June 2021, Franchise Group had a debt of US $ 1.25 billion, an increase from US $ 739.3 million. , over one year. On the flip side, it has $ 165.4 million in cash, resulting in net debt of around $ 1.09 billion.
NasdaqGM: FRG History of debt to equity October 2, 2021
How strong is the Franchise group’s balance sheet?
Zooming in on the latest balance sheet data, we can see that Franchise Group had liabilities of US $ 585.1 million due within 12 months and US $ 1.81 billion liabilities beyond. On the other hand, he had $ 165.4 million in cash and $ 81.1 million in receivables due within one year. Its liabilities therefore total $ 2.15 billion more than the combination of its cash and short-term receivables.
When you consider that this shortfall exceeds the company’s US $ 1.47 billion market capitalization, you may well be inclined to take a close look at the balance sheet. Hypothetically, an extremely high dilution would be necessary if the company were forced to repay its debts by raising capital at the current share price.
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). The advantage of this approach is that we take into account both the absolute amount of debt (with net debt versus EBITDA) and the actual interest charges associated with this debt (with its coverage rate). interests).
While the Franchise Group’s debt / EBITDA ratio (4.0) suggests that it is using some debt, its interest coverage is very low at 1.8, suggesting high leverage. Shareholders should therefore probably be aware that interest charges seem to have had a real impact on the company in recent times. A buyout factor for Franchise Group is that it turned last year’s loss of EBIT into a gain of US $ 210 million, over the past twelve months. There is no doubt that we learn the most about debt from the balance sheet. But it is future profits, more than anything, that will determine the Franchise Group’s ability to maintain a healthy balance sheet in the future. So if you want to see what the pros think about it, you might find this free report on analysts’ earnings forecasts Be interesting.
But our last consideration is also important, because a company cannot pay its debts with paper profits; he needs hard cash. It is therefore worth checking to what extent earnings before interest and taxes (EBIT) are backed by free cash flow. In the most recent year, Franchise Group recorded free cash flow of 72% of its EBIT, which is close to normal, given that free cash flow excludes interest and taxes. This free cash flow puts the business in a good position to repay debt, if any.
Our point of view
At first glance, Franchise Group’s interest hedging left us hesitant about the stock, and its total liability level was no more attractive than the lone restaurant empty on the busiest night of the year. But on the positive side, its conversion from EBIT to free cash flow is a good sign and makes us more optimistic. Overall, we think it’s fair to say that Franchise Group has enough debt that there is real risk around the balance sheet. If all goes well, this should increase returns, but on the other hand, the risk of permanent capital loss is increased by debt. The balance sheet is clearly the area you need to focus on when analyzing debt. However, not all investment risks lie on the balance sheet – far from it. Concrete example: we have spotted 3 warning signs for Franchise Group you need to be aware of it, and one of them is potentially serious.
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.
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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