Warren Buffett famously said, 'Volatility is far from synonymous with risk.' So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. Importantly, BJ's Restaurants, Inc. (NASDAQ:BJRI) does carry debt. But the real question is whether this debt is making the company risky.
What Risk Does Debt Bring?
Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. Of course, plenty of companies use debt to fund growth, without any negative consequences. The first step when considering a company's debt levels is to consider its cash and debt together.
How Much Debt Does BJ's Restaurants Carry?
The image below, which you can click on for greater detail, shows that BJ's Restaurants had debt of US$100.0m at the end of July 2019, a reduction from US$110.0m over a year. On the flip side, it has US$23.4m in cash leading to net debt of about US$76.6m.
How Strong Is BJ's Restaurants's Balance Sheet?
According to the last reported balance sheet, BJ's Restaurants had liabilities of US$156.2m due within 12 months, and liabilities of US$575.0m due beyond 12 months. Offsetting this, it had US$23.4m in cash and US$17.7m in receivables that were due within 12 months. So it has liabilities totalling US$690.2m more than its cash and near-term receivables, combined.
This is a mountain of leverage relative to its market capitalization of US$736.2m. This suggests shareholders would heavily diluted if the company needed to shore up its balance sheet in a hurry.
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).
BJ's Restaurants's net debt is only 0.60 times its EBITDA. And its EBIT easily covers its interest expense, being 13.4 times the size. So we're pretty relaxed about its super-conservative use of debt. Fortunately, BJ's Restaurants grew its EBIT by 5.6% in the last year, making that debt load look even more manageable. The balance sheet is clearly the area to focus on when you are analysing debt. But it is future earnings, more than anything, that will determine BJ's Restaurants'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, 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. During the last three years, BJ's Restaurants generated free cash flow amounting to a very robust 86% of its EBIT, more than we'd expect. That puts it in a very strong position to pay down debt.
BJ's Restaurants's interest cover suggests it can handle its debt as easily as Cristiano Ronaldo could score a goal against an under 14's goalkeeper. But truth be told we feel its level of total liabilities does undermine this impression a bit. Looking at all the aforementioned factors together, it strikes us that BJ's Restaurants can handle its debt fairly comfortably. On the plus side, this leverage can boost shareholder returns, but the potential downside is more risk of loss, so it's worth monitoring the balance sheet. We'd be motivated to research the stock further if we found out that BJ's Restaurants insiders have bought shares recently. If you would too, then you're in luck, since today we're sharing our list of reported insider transactions for free.
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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