Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett said “volatility is far from risk.” So it seems like smart money knows that debt – which is usually involved in bankruptcies – is a very important factor, when you assess the level of risk of a business. We notice that Unifi, Inc. (NYSE: UFI) has debt on its balance sheet. But does this debt worry shareholders?
What risk does debt entail?
Generally speaking, debt only becomes a real problem when a company cannot repay it easily, either by raising capital or with its own cash flow. An integral part of capitalism is the process of “creative destruction” where bankrupt companies are ruthlessly liquidated by their bankers. However, a more common (but still costly) situation is where a company has to dilute its shareholders at a cheap share price just to get its debt under control. Of course, debt can be an important tool in businesses, especially capital intensive businesses. When we think of a business’s use of debt, we first look at cash flow and debt together.
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What is Unifi’s debt?
The image below, which you can click for more details, shows Unifi owed $ 81.0 million in debt at the end of March 2021, a reduction from $ 122.7 million. US over one year. However, given that it has a reserve of US $ 75.6 million, its net debt is less, at around US $ 5.43 million.
A look at Unifi’s responsibilities
According to the latest published balance sheet, Unifi had liabilities of US $ 100.6 million due within 12 months and liabilities of US $ 92.2 million due beyond 12 months. In return, he had $ 75.6 million in cash and $ 109.0 million in receivables due within 12 months. As a result, its liabilities exceed the sum of its cash and (short-term) receivables by $ 8.19 million.
Considering that Unifi has a market capitalization of US $ 393.3 million, it is hard to believe that these liabilities pose a significant threat. Having said that, it is clear that we must continue to monitor his record lest it get worse. But in any case, Unifi has virtually no net debt, so it’s fair to say that it doesn’t have a lot of debt!
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). Thus, we consider debt versus earnings with and without amortization charges.
While Unifi’s low debt-to-EBITDA ratio of 0.16 suggests only a modest use of debt, the fact that EBIT only covered interest expense 2.9 times last year makes us think. But the interest payments are certainly enough to make us think about how affordable his debt is. Shareholders should know that Unifi’s EBIT fell by 50% last year. If this earnings trend continues, paying off debt will be about as easy as driving cats on a roller coaster. The balance sheet is clearly the area you need to focus on when analyzing debt. But it is future profits, more than anything, that will determine Unifi’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 analyst earnings forecast report interesting.
But our last consideration is also important, because a business cannot pay its debts with paper profits; he needs hard cash. We must therefore clearly check whether this EBIT generates a corresponding free cash flow. Over the past three years, Unifi has generated strong free cash flow equivalent to 71% of its EBIT, roughly what we expected. This hard cash allows him to reduce his debt whenever he wants.
Our point of view
Unifi’s EBIT growth rate was really negative on this analysis, although the other factors we considered were considerably better. In particular, we are dazzled by its net debt on EBITDA. Given this range of data points, we believe Unifi is well positioned to manage its debt levels. But beware: we believe debt levels are high enough to warrant continued monitoring. There is no doubt that we learn the most about debt from the balance sheet. But at the end of the day, every business can contain risks that exist off the balance sheet. These risks can be difficult to spot. Every business has them, and we’ve spotted 1 warning sign for Unifi you should know.
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.
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