Some say that volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett once said that “volatility is far from synonymous with risk.” It seems the smart money knows that debt – which usually comes with bankruptcies – is a very important factor when you assess how risky a company is. important, Kerry Group plc (ISE:KRZ) does bear debt. But the most important question is: how much risk does that debt create?
When is debt dangerous?
In general, debt only becomes a real problem if a company cannot easily pay it off, either by raising capital or using its own cash flow. If the company can’t meet its legal obligations to repay debts, shareholders may end up walking away with nothing. While not too common, we often see indebted companies permanently diluting their shareholders as lenders force them to raise capital at a difficult price. That said, the most common situation is for a company to manage its debt fairly well — and for its own benefit. The first thing to do when considering how much debt a company uses is to look at its cash and debt together.
What is Kerry Group’s Net Debt?
The chart below, which you can click on for more details, shows Kerry Group had €2.51 billion in debt in December 2020; about the same as the year before. However, it also had $563.1 million in cash, so its net debt is $1.95 billion.
How healthy is Kerry Group’s balance sheet?
The most recent balance sheet data shows that Kerry Group had debts of €1.70 billion that were due within one year, and liabilities of €3.09 billion that fell due afterwards. This was offset by €563.1 million in cash and €1.04 billion in receivables due within 12 months. So its liabilities are €3.18 billion greater than the sum of its cash and (current) receivables.
Given that Kerry Group’s publicly traded shares are worth a very impressive total of €19.2 billion, it seems unlikely that this level of liabilities would pose a major threat. But there are plenty of commitments that we definitely recommend to shareholders to keep track of the balance sheet going forward.
To upgrade a company’s debt relative to revenue, we calculate net debt divided by revenue before interest, taxes, depreciation, and amortization (EBITDA) and revenue before interest and tax (EBIT) divided by interest expense (are interest coverage). The advantage of this approach is that we take into account both the absolute amount of debt (with net debt to EBITDA) and the actual interest expense associated with that debt (with the interest coverage ratio).
With a debt to EBITDA ratio of 2.1, Kerry Group uses debt smartly but responsibly. And the attractive interest coverage (EBIT of 10.0 times interest expense) certainly does that not do anything to dispel this impression. The bad news is that Kerry Group saw its EBIT drop by 13% in the past year. If revenues continue to fall at that rate, it will be harder to deal with debt than going to a fancy trouser restaurant with three kids under five. There is no doubt that we learn the most about debt from the balance sheet. But ultimately, the future profitability of the company will decide whether Kerry Group can strengthen its balance sheet over time. So if you want to see what the pros think, you might find this free analyst earnings forecast report be interesting.
Finally, a company can only pay off debt with cold hard cash, not accounting profits. So we need to see clearly whether that EBIT leads to a corresponding free cash flow. Over the last three years, Kerry Group has produced solid free cash flow equal to 51% of its EBIT, roughly what we would expect. This cold hard money means it can reduce its debt whenever it wants to.
According to our analysis, Kerry Group’s interest coverage should indicate that it will not have too many problems with its debt. But the other factors we noted above weren’t as encouraging. To be specific, it seems to be about as good at (not) growing its EBIT as wet socks are at keeping your feet warm. Considering all of the above factors, we are a little cautious about Kerry Group’s use of debt. While debt has its upsides in higher potential returns, we think shareholders should definitely consider how debt levels can make the stock more risky. When analyzing debt levels, the balance sheet is the obvious place to start. However, not all investment risks reside within the balance sheet – far from it. Example: we’ve seen it 1 warning sign for Kerry Group you should be aware.
If you’re more interested in a fast-growing company with a rock-solid balance sheet, take a look our list of net cash growth stocks without delay.
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