Hormel Foods (NYSE:HRL) Seems To Use Debt Quite Sensibly

Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. As with many other companies Hormel Foods Corporation (NYSE:HRL) makes use of debt. But the more important question is: how much risk is that debt creating?

When Is Debt A Problem?

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 frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. When we examine debt levels, we first consider both cash and debt levels, together.

See our latest analysis for Hormel Foods

What Is Hormel Foods's Net Debt?

The image below, which you can click on for greater detail, shows that at January 2021 Hormel Foods had debt of US$1.19b, up from US$250.0m in one year. However, its balance sheet shows it holds US$1.77b in cash, so it actually has US$583.5m net cash.

How Strong Is Hormel Foods' Balance Sheet?

We can see from the most recent balance sheet that Hormel Foods had liabilities of US$1.42b falling due within a year, and liabilities of US$1.98b due beyond that. Offsetting this, it had US$1.77b in cash and US$715.7m in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by US$917.5m.

Given Hormel Foods has a humongous market capitalization of US$25.5b, it's hard to believe these liabilities pose much threat. Having said that, it's clear that we should continue to monitor its balance sheet, lest it change for the worse. While it does have liabilities worth noting, Hormel Foods also has more cash than debt, so we're pretty confident it can manage its debt safely.

While Hormel Foods doesn't seem to have gained much on the EBIT line, at least earnings remain stable for now. There's no doubt that we learn most about debt from the balance sheet. But ultimately the future profitability of the business will decide if Hormel Foods can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. While Hormel Foods has net cash on its balance sheet, it's still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. During the last three years, Hormel Foods produced sturdy free cash flow equating to 63% of its EBIT, about what we'd expect. This cold hard cash means it can reduce its debt when it wants to.

Summing up

We could understand if investors are concerned about Hormel Foods's liabilities, but we can be reassured by the fact it has has net cash of US$583.5m. So we don't think Hormel Foods's use of debt is risky. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. For example - Hormel Foods has 1 warning sign we think you should be aware of.

At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.

This article by Simply Wall St is general in nature. 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.

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