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.' So it seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. We note that BJ's Restaurants, Inc. (NASDAQ:BJRI) does have debt on its balance sheet. But is this debt a concern to shareholders?
Why Does Debt Bring Risk?
Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. 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, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. When we examine debt levels, we first consider both cash and debt levels, together.
What Is BJ's Restaurants's Debt?
The image below, which you can click on for greater detail, shows that at January 2024 BJ's Restaurants had debt of US$68.0m, up from US$60.0m in one year. However, it also had US$29.1m in cash, and so its net debt is US$38.9m.
A Look At BJ's Restaurants' Liabilities
According to the last reported balance sheet, BJ's Restaurants had liabilities of US$199.3m due within 12 months, and liabilities of US$493.4m due beyond 12 months. Offsetting these obligations, it had cash of US$29.1m as well as receivables valued at US$19.5m due within 12 months. So its liabilities total US$644.2m more than the combination of its cash and short-term receivables.
This is a mountain of leverage relative to its market capitalization of US$795.9m. Should its lenders demand that it shore up the balance sheet, shareholders would likely face severe dilution.
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). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.
While BJ's Restaurants's low debt to EBITDA ratio of 0.42 suggests only modest use of debt, the fact that EBIT only covered the interest expense by 4.5 times last year does give us pause. So we'd recommend keeping a close eye on the impact financing costs are having on the business. We also note that BJ's Restaurants improved its EBIT from a last year's loss to a positive US$22m. 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 BJ's Restaurants can strengthen its balance sheet over time. So if you're focused on the future you can check out this free report showing analyst profit forecasts.
But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So it's worth checking how much of the earnings before interest and tax (EBIT) is backed by free cash flow. Looking at the most recent year, BJ's Restaurants recorded free cash flow of 32% of its EBIT, which is weaker than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.
Our View
BJ's Restaurants's level of total liabilities and conversion of EBIT to free cash flow definitely weigh on it, in our esteem. But its net debt to EBITDA tells a very different story, and suggests some resilience. When we consider all the factors discussed, it seems to us that BJ's Restaurants is taking some risks with its use of debt. So while that leverage does boost returns on equity, we wouldn't really want to see it increase from here. 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. For example - BJ's Restaurants has 1 warning sign we think you should be aware of.
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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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.