David Iben put it well when he said, ‘Volatility is not a risk we care about. What we care about is avoiding the permanent loss of capital.’ It’s only natural to consider a company’s balance sheet when you examine how risky it is, since debt is often involved when a business collapses. We can see that SpartanNash Company (NASDAQ:SPTN) does use debt in its business. But is this debt a concern to shareholders?

When Is Debt A Problem?

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. If things get really bad, the lenders can take control of the business. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. Having said that, the most common situation is where a company manages its debt reasonably well – and to its own advantage. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

What Is SpartanNash’s Debt?

You can click the graphic below for the historical numbers, but it shows that SpartanNash had US$527.1m of debt in April 2021, down from US$597.3m, one year before. However, because it has a cash reserve of US$23.3m, its net debt is less, at about US$503.8m.

How Healthy Is SpartanNash’s Balance Sheet?

Zooming in on the latest balance sheet data, we can see that SpartanNash had liabilities of US$629.0m due within 12 months and liabilities of US$896.0m due beyond that. Offsetting these obligations, it had cash of US$23.3m as well as receivables valued at US$346.7m due within 12 months. So its liabilities total US$1.16b more than the combination of its cash and short-term receivables.

Given this deficit is actually higher than the company’s market capitalization of US$773.8m, we think shareholders really should watch SpartanNash’s debt levels, like a parent watching their child ride a bike for the first time. In the scenario where the company had to clean up its balance sheet quickly, it seems likely shareholders would suffer extensive dilution.

In order to size up a company’s debt relative to its earnings, we calculate its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and its earnings before interest and tax (EBIT) divided by its interest expense (its interest cover). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

With a debt to EBITDA ratio of 2.3, SpartanNash uses debt artfully but responsibly. And the fact that its trailing twelve months of EBIT was 8.1 times its interest expenses harmonizes with that theme. Importantly, SpartanNash grew its EBIT by 80% over the last twelve months, and that growth will make it easier to handle its debt. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately the future profitability of the business will decide if SpartanNash can strengthen its balance sheet over time.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So we always check how much of that EBIT is translated into free cash flow. Over the last three years, SpartanNash actually produced more free cash flow than EBIT. That sort of strong cash generation warms our hearts like a puppy in a bumblebee suit.

Our View

Both SpartanNash’s ability to to convert EBIT to free cash flow and its EBIT growth rate gave us comfort that it can handle its debt. In contrast, our confidence was undermined by its apparent struggle to handle its total liabilities. Looking at all this data makes us feel a little cautious about SpartanNash’s debt levels. While debt does have its upside in higher potential returns, we think shareholders should definitely consider how debt levels might make the stock more risky. When analysing debt levels, the balance sheet is the obvious place to start.