Canadian company SunOpta (STKL 1.47%) supplies retailers and packaged food companies with organic ingredients from all over the world. It has seen its stock price decline in recent years, but that doesn't always indicate a good buying opportunity. Three key red flags in SunOpta's business suggest that investors should think twice before putting money in.

Declining earnings

The most important factor in determining the long-term direction of a company's value is to look at the long-term direction of its earnings. Businesses that earn more money every year will almost certainly be worth more to their owners in the future. Unfortunately, SunOpta has seen its profits and profit margin decline for several years.

STKL Operating Income (TTM) Chart

STKL Operating Income (TTM) data by YCharts

SunOpta's earnings have dropped despite a long-running margin improvement program launched in 2017. As part of the plan, it targeted layoffs in corporate staff and consolidated manufacturing facilities in order to cut expenses without denting sales. Although SunOpta has achieved cost savings, its progress has been outweighed by a broader industry trend toward falling food prices at grocery stores, resulting in lower sale prices for its products.

The drop in food prices has been an ongoing theme in the grocery industry. As a middleman between food producers and retailers, SunOpta has little choice but to give up margin when grocery store pricing falls. There is little sign of food inflation picking up, and if the company's customers continue to demand lower prices, margins will most likely compress further.

High debt load

At the end of Q4 2018, SunOpta had $509.2 million in total debt and only $3.3 million in cash. Based on a ratio of the company's total debt to EBITDA, total leverage at the end of the year was 9.6x. EBITDA is a measure of a company's earnings before interest taxes depreciation and amortization, and is commonly used as a proxy for cash flow available to service debt. A leverage ratio above 5.0x is generally considered high, but 9.6x is extremely high -- especially for a company with declining earnings.

Metrics SunOpta financials
Total debt as of Q4 2018 $509.2 million
FY 2018 EBITDA $52.9 million
Total debt to EBITDA leverage ratio 9.6x

Data Source: SunOpta financial reports.

SunOpta clearly needs to reduce its debt load or it could risk insolvency. The company has significant debt maturities in 2021 and 2022 and its lenders could force the company to recapitalize if they are uncomfortable with SunOpta's balance sheet.

The company has embarked on a program to sell some of its assets to help alleviate its debt burden. Last quarter, it agreed to sell its organic soy and corn business for $64 million. The deal will cut the company's total debt to about $445 million, but it will also lose the earnings associated with that business.

SunOpta has noted that it will continue to optimize its asset portfolio. That means it could sell more assets, which could help further ease its debt load. Regardless, the company's debt has created a risky balance sheet that will be a significant red flag for the foreseeable future.

Leadership concerns

As a minority shareholder of a business, you want to be able to trust the team running the company. At SunOpta, leadership has come and gone so frequently that it is hard to have faith in the management team. In the past two years, a number of high-level executives have resigned or been terminated, including the CFO and COO. In the last quarter, CEO David Colo was dismissed, and an interim has been appointed until a permanent CEO is named.

SunOpta is already a risky stock because of its declining earnings and high leverage. A capable management team will be needed to turn the ship around and avoid a continuation of the negative trends. The fact that the company does not have a permanent CEO is a major red flag that should shake investor confidence in the company.

Man shopping in grocery store.

Image Source: Getty Images.

A lower stock price isn't always a buying opportunity

SunOpta is in a hairy situation. The company operates in a competitive industry where its customers are squeezing its profit margins, has a large debt load that won't be easy to address, and lacks a stable management team that can guide it through its turnaround. Considering these three major red flags, it's no wonder its stock price has declined.

Simply because the stock price has fallen a great deal doesn't mean there is an obvious buying opportunity. SunOpta doesn't seem to have a clear solution to its problems, which could get worse before they get better. Investors should be well aware of the risks and proceed carefully.