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Is Dunkin' Brands' Debt Burden Too Much to Handle?

http://www.fool.com/investing/general/2012/06/11/is-dunkin-brands-debt-burden-too-much-to-handle-.aspx

Shubh Datta
June 11, 2012

Taking on too much debt may sound like a bad thing, but it's not always. Sometimes, debt-laden companies can provide solid returns. Let's see how.

Generally, the cost of raising debt is cheaper than the cost of raising equity. Raising debt against equity has two observable consequences -- first, the equity that shareholders value doesn't get diluted, and second, it results in a higher interest expense. As interest is charged before tax, a higher interest rate provides a tax shield, thus resulting in higher profits. Higher profits coupled with a lower share count translate into higher earnings per share.

However, when assuming debt, a company should see whether the returns from investing the money are higher than the cost of the debt itself. If not, the company is headed for some serious trouble.

It's prudent for investors to see whether a company is strongly positioned to handle the debt it has taken on -- i.e., comfortably meet its short-term liabilities and interest payments. Let's look at three simple metrics to help us understand debt positions.

  • The debt-to-equity ratio tells us what fraction of the debt as opposed to equity a company uses to help fund its assets.
  • The interest coverage ratio is a way of measuring how easily a company can pay off the interest expenses on its outstanding debt.
  • The current ratio tells us what proportion of a company's short-term assets is available to finance its short-term liabilities.

And now let's examine the debt situation at Dunkin' Brands (Nasdaq: DNKN  ) and compare it with its peers.

Company

Debt-Equity Ratio

Interest Coverage

Current Ratio

Dunkin' Brands 196.1% 2.5 1.4
Krispy Kreme Doughnuts (NYSE: KKD