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. As with many other companies Darden Restaurants, Inc. (NYSE:DRI) makes use of debt. But the more important question is: how much risk is that debt creating?
When Is Debt Dangerous?
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. 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, 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.
What Is Darden Restaurants's Debt?
As you can see below, Darden Restaurants had US$936.7m of debt, at August 2021, which is about the same as the year before. You can click the chart for greater detail. However, its balance sheet shows it holds US$954.3m in cash, so it actually has US$17.6m net cash.
A Look At Darden Restaurants' Liabilities
Zooming in on the latest balance sheet data, we can see that Darden Restaurants had liabilities of US$1.72b due within 12 months and liabilities of US$6.07b due beyond that. Offsetting these obligations, it had cash of US$954.3m as well as receivables valued at US$51.9m due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by US$6.78b.
Darden Restaurants has a very large market capitalization of US$17.9b, 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. While it does have liabilities worth noting, Darden Restaurants also has more cash than debt, so we're pretty confident it can manage its debt safely.
Even more impressive was the fact that Darden Restaurants grew its EBIT by 198% over twelve months. That boost will make it even 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 Darden Restaurants'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. Darden Restaurants may have net cash on the balance sheet, but it is still interesting to look at how well the business converts its earnings before interest and tax (EBIT) to free cash flow, because that will influence both its need for, and its capacity to manage debt. During the last three years, Darden Restaurants generated free cash flow amounting to a very robust 94% of its EBIT, more than we'd expect. That puts it in a very strong position to pay down debt.
Summing up
Although Darden Restaurants's balance sheet isn't particularly strong, due to the total liabilities, it is clearly positive to see that it has net cash of US$17.6m. The cherry on top was that in converted 94% of that EBIT to free cash flow, bringing in US$854m. So is Darden Restaurants's debt a risk? It doesn't seem so to us. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. Case in point: We've spotted 2 warning signs for Darden Restaurants you should be aware of.
If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.
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This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.
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