Warren Buffett famously said, 'Volatility is far from synonymous with risk.' So it seems the smart money knows that debt – which is usually involved in bankruptcies – is a very important factor, when you assess how risky a company is. Importantly, Aramark (NYSE:ARMK) does carry debt. But the more important question is: how much risk is that debt creating?
Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. Of course, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. When we examine debt levels, we first consider both cash and debt levels, together.
Check out our latest analysis for Aramark
As you can see below, Aramark had US$7.65b of debt, at April 2022, which is about the same as the year before. You can click the chart for greater detail. However, it does have US$429.3m in cash offsetting this, leading to net debt of about US$7.22b.
The latest balance sheet data shows that Aramark had liabilities of US$2.70b due within a year, and liabilities of US$9.05b falling due after that. Offsetting this, it had US$429.3m in cash and US$1.99b in receivables that were due within 12 months. So its liabilities total US$9.33b more than the combination of its cash and short-term receivables.
When you consider that this deficiency exceeds the company's US$9.30b market capitalization, you might well be inclined to review the balance sheet intently. In the scenario where the company had to clean up its balance sheet quickly, it seems likely shareholders would suffer extensive dilution.
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). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.
Weak interest cover of 1.4 times and a disturbingly high net debt to EBITDA ratio of 6.7 hit our confidence in Aramark like a one-two punch to the gut. The debt burden here is substantial. One redeeming factor for Aramark is that it turned last year's EBIT loss into a gain of US$539m, over the last twelve months. There's no doubt that we learn most about debt from the balance sheet. But it is future earnings, more than anything, that will determine Aramark's ability to maintain a healthy balance sheet going forward. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.
Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. So it's worth checking how much of the earnings before interest and tax (EBIT) is backed by free cash flow. Over the last year, Aramark saw substantial negative free cash flow, in total. While investors are no doubt expecting a reversal of that situation in due course, it clearly does mean its use of debt is more risky.
To be frank both Aramark's net debt to EBITDA and its track record of converting EBIT to free cash flow make us rather uncomfortable with its debt levels. But at least its EBIT growth rate is not so bad. After considering the datapoints discussed, we think Aramark has too much debt. While some investors love that sort of risky play, it's certainly not our cup of tea. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet – far from it. These risks can be hard to spot. Every company has them, and we've spotted 1 warning sign for Aramark you should know about.
When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.
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Aramark provides food, facilities, and uniform services to education, healthcare, business and industry, sports, leisure, and corrections clients in the United States and internationally.
Moderate growth potential with poor track record.
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