Is Hershey (NYSE: HSY) a risky investment?
Legendary fund manager Li Lu (who Charlie Munger supported) once said, “The biggest risk in investing is not price volatility, but the possibility that you will suffer a permanent loss of capital. So it seems like smart money knows that debt – which is usually involved in bankruptcies – is a very important factor, when you assess the level of risk of a business. We note that The Hershey Company (NYSE: HSY) has debt on its balance sheet. But does this debt worry shareholders?
When Is Debt a Problem?
Debt is a tool to help businesses grow, but if a business is unable to repay its lenders, then it exists at their mercy. An integral part of capitalism is the process of “creative destruction” where bankrupt companies are ruthlessly liquidated by their bankers. However, a more common (but still costly) situation is where a company has to dilute its shareholders at a cheap share price just to get its debt under control. By replacing dilution, however, debt can be a very good tool for companies that need capital to invest in growth at high rates of return. The first step in examining a company’s debt levels is to consider its cash flow and debt together.
Check out our latest analysis for Hershey
How much debt does Hershey have?
The image below, which you can click for more details, shows Hershey had US $ 4.23 billion in debt at the end of July 2021, a reduction from US $ 5.00 billion. over a year. However, it has $ 426.2 million in cash offsetting that, leading to net debt of around $ 3.80 billion.
How strong is Hershey’s balance sheet?
We can see from the most recent balance sheet that Hershey had liabilities of US $ 1.59 billion due within one year and liabilities of US $ 5.02 billion due beyond. On the other hand, it had US $ 426.2 million in cash and US $ 532.4 million in receivables due within one year. As a result, its liabilities exceed the sum of its cash and (short-term) receivables by US $ 5.65 billion.
Of course, Hershey has a titanic market cap of US $ 36.2 billion, so this liability is likely manageable. However, we think it’s worth keeping an eye on the strength of its balance sheet as it can change over time.
In order to measure a company’s debt relative to its profits, we calculate its net debt divided by its earnings before interest, taxes, depreciation and amortization (EBITDA) and its profit before interest and taxes (EBIT) divided by its interest. debtors (its interest coverage). In this way, we consider both the absolute amount of debt, as well as the interest rates paid on it.
Hershey’s net debt to EBITDA ratio of around 1.6 suggests only a moderate use of debt. And its imposing EBIT of 14.4 times its interest costs, means the debt load is as light as a peacock feather. Another good sign is that Hershey was able to increase their EBIT by 28% in twelve months, making it easier to pay off debt. The balance sheet is clearly the area you need to focus on when analyzing debt. But it is future profits, more than anything, that will determine Hershey’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 can only pay off its debts with hard cash, not with book profits. The logical step is therefore to examine the proportion of this EBIT that corresponds to the actual free cash flow. Over the past three years, Hershey has generated free cash flow of 80% of its very robust EBIT, more than we expected. This puts him in a very strong position to pay off the debt.
Our point of view
The good news is that Hershey’s demonstrated ability to cover interest costs with his EBIT delights us like a fluffy puppy does a toddler. And this is only the beginning of good news as its conversion from EBIT to free cash flow is also very encouraging. Overall, we don’t think Hershey is taking bad risks, as his debt load looks modest. The balance sheet therefore seems rather healthy to us. The balance sheet is clearly the area you need to focus on when analyzing debt. However, not all investment risks lie on the balance sheet – far from it. Be aware that Hershey shows 1 warning sign in our investment analysis , you must know…
Of course, if you are the type of investor who prefers to buy stocks without going into debt, feel free to check out our exclusive list of cash growth net stocks today.
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