Aramark (NYSE:ARMK) Using Debt Could Be Considered Risky

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Warren Buffett said: “Volatility is far from synonymous with risk. So it seems smart money knows that debt – which is usually involved in bankruptcies – is a very important factor when you’re assessing a company’s risk. Above all, Aramark (NYSE: ARMK) is in debt. But the more important question is: what risk does this debt create?

When is debt a problem?

Debt is a tool to help businesses grow, but if a business is unable to repay its lenders, it exists at their mercy. In the worst case, a company can go bankrupt if it cannot pay its creditors. However, a more common (but still costly) situation is when a company has to dilute shareholders at a cheap share price just to keep debt under control. Of course, the advantage of debt is that it often represents cheap capital, especially when it replaces dilution in a business with the ability to reinvest at high rates of return. When we look at debt levels, we first consider cash and debt levels, together.

Check out our latest analysis for Aramark

What is Aramark’s debt?

As you can see below, Aramark had $7.65 billion in debt as of April 2022, roughly the same as the previous year. You can click on the graph for more details. However, he has $429.3 million in cash to offset this, resulting in a net debt of approximately $7.22 billion.

NYSE: ARMK Debt to Equity History August 10, 2022

How healthy is Aramark’s balance sheet?

The latest balance sheet data shows that Aramark had liabilities of $2.70 billion due within the year, and liabilities of $9.05 billion due thereafter. In return, it had $429.3 million in cash and $1.99 billion in receivables due within 12 months. Thus, its liabilities total $9.33 billion more than the combination of its cash and short-term receivables.

When you consider that shortfall exceeds the company’s US$9.30 billion market capitalization, you might well be inclined to take a close look at the balance sheet. In the scenario where the company were to quickly clean up its balance sheet, it seems likely that shareholders would suffer significant dilution.

We measure a company’s leverage against its earning power by looking at its net debt divided by its earnings before interest, taxes, depreciation and amortization (EBITDA) and calculating how easily its earnings before interest and taxes (EBIT ) covers its interest charge (interest coverage). In this way, we consider both the absolute amount of debt, as well as the interest rates paid on it.

Low interest coverage of 1.4x and an extremely high net debt to EBITDA ratio of 6.7 hit our confidence in Aramark like a punch in the gut. The debt burden here is considerable. A redeeming factor for Aramark is that it turned last year’s EBIT loss into a US$539 million gain over the past twelve months. There is no doubt that we learn the 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 in the future. So if you want to see what the professionals think, you might find this free analyst earnings forecast report interesting.

Finally, a business needs free cash flow to pay off its debts; book profits are not enough. It is therefore worth checking how much of earnings before interest and tax (EBIT) is supported by free cash flow. Over the past year, Aramark has experienced substantial negative free cash flow, overall. While investors no doubt expect a reversal of this situation in due course, this clearly means that its use of debt is more risky.

Our point of view

To be frank, Aramark’s net debt to EBITDA ratio and history of converting EBIT to free cash flow makes us rather uncomfortable with its debt levels. But at least its EBIT growth rate isn’t that bad. After reviewing the data points discussed, we believe that Aramark has too much debt. While some investors like this kind of risky play, it’s definitely not our cup of tea. The balance sheet is clearly the area to focus on when analyzing debt. However, not all investment risks reside on the balance sheet, far from it. These risks can be difficult to spot. Every business has them, and we’ve spotted 1 warning sign for Aramark you should know.

In the end, sometimes it’s easier to focus on companies that don’t even need to take on debt. Readers can access a list of growth stocks with no net debt 100% freeat present.

This Simply Wall St article is general in nature. We provide commentary based on historical data and analyst forecasts only using unbiased methodology and our articles are not intended to be financial advice. It is not a recommendation to buy or sell stocks and does not take into account your objectives or financial situation. Our goal is to bring you targeted long-term analysis based on fundamental data. Note that our analysis may not take into account the latest announcements from price-sensitive companies or qualitative materials. Simply Wall St has no position in the stocks mentioned.

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