Is Flowers Foods (NYSE:FLO) Using Too Much Debt?
Warren Buffett famously said, ‘Volatility is far from synonymous with risk.’ It’s only natural to consider a company’s balance sheet when you examine how risky it is, since debt is often involved when a business collapses. As with many other companies Flowers Foods, Inc. (NYSE:FLO) makes use of debt. But should shareholders be worried about its use of debt?
Why Does Debt Bring Risk?
Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. If things get really bad, the lenders can take control of the business. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. Of course, plenty of companies use debt to fund growth, without any negative consequences. When we examine debt levels, we first consider both cash and debt levels, together.
View our latest analysis for Flowers Foods
How Much Debt Does Flowers Foods Carry?
As you can see below, Flowers Foods had US$900.1m of debt at April 2021, down from US$1.08b a year prior. On the flip side, it has US$250.6m in cash leading to net debt of about US$649.5m.
How Strong Is Flowers Foods’ Balance Sheet?
We can see from the most recent balance sheet that Flowers Foods had liabilities of US$461.2m falling due within a year, and liabilities of US$1.40b due beyond that. Offsetting this, it had US$250.6m in cash and US$298.3m in receivables that were due within 12 months. So it has liabilities totalling US$1.31b more than its cash and near-term receivables, combined.
Flowers Foods has a market capitalization of US$4.98b, so it could very likely raise cash to ameliorate its balance sheet, if the need arose. But we definitely want to keep our eyes open to indications that its debt is bringing too much risk.
We measure a company’s debt load relative to its earnings power by looking at its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and by calculating how easily its earnings before interest and tax (EBIT) cover its interest expense (interest cover). The advantage of this approach is that we take into account both the absolute quantum of debt (with net debt to EBITDA) and the actual interest expenses associated with that debt (with its interest cover ratio).
Flowers Foods has a low net debt to EBITDA ratio of only 1.3. And its EBIT easily covers its interest expense, being 28.2 times the size. So you could argue it is no more threatened by its debt than an elephant is by a mouse. Also positive, Flowers Foods grew its EBIT by 20% in the last year, and that should make it easier to pay down debt, going forward. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Flowers Foods’s ability to maintain a healthy balance sheet going forward. So if you’re focused on the future you can check out this free report showing analyst profit forecasts.
Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So it’s worth checking how much of that EBIT is backed by free cash flow. Over the last three years, Flowers Foods recorded free cash flow worth a fulsome 88% of its EBIT, which is stronger than we’d usually expect. That puts it in a very strong position to pay down debt.
Happily, Flowers Foods’s impressive interest cover implies it has the upper hand on its debt. And the good news does not stop there, as its conversion of EBIT to free cash flow also supports that impression! Zooming out, Flowers Foods seems to use debt quite reasonably; and that gets the nod from us. While debt does bring risk, when used wisely it can also bring a higher return on equity. There’s no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet – far from it. Be aware that Flowers Foods is showing 1 warning sign in our investment analysis , you should know about…
At the end of the day, it’s often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It’s free.
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