Warren Buffett famously said, 'Volatility is far from synonymous with risk.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. Importantly, Ingredion Incorporated (NYSE:INGR) does carry debt. But the more important question is: how much risk is that debt creating?
When Is Debt A Problem?
Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. 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, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. The first step when considering a company's debt levels is to consider its cash and debt together.
How Much Debt Does Ingredion Carry?
The image below, which you can click on for greater detail, shows that at June 2022 Ingredion had debt of US$2.39b, up from US$2.20b in one year. On the flip side, it has US$322.0m in cash leading to net debt of about US$2.07b.
A Look At Ingredion's Liabilities
According to the last reported balance sheet, Ingredion had liabilities of US$1.85b due within 12 months, and liabilities of US$2.31b due beyond 12 months. Offsetting these obligations, it had cash of US$322.0m as well as receivables valued at US$1.29b due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by US$2.55b.
Ingredion has a market capitalization of US$5.35b, so it could very likely raise cash to ameliorate its balance sheet, if the need arose. But we definitely want to keep our eyes open to indications that its debt is bringing too much risk.
We measure a company's debt load relative to its earnings power by looking at its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and by calculating how easily its earnings before interest and tax (EBIT) cover its interest expense (interest cover). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.
Ingredion's net debt of 2.3 times EBITDA suggests graceful use of debt. And the fact that its trailing twelve months of EBIT was 9.1 times its interest expenses harmonizes with that theme. Sadly, Ingredion's EBIT actually dropped 8.5% in the last year. If that earnings trend continues then its debt load will grow heavy like the heart of a polar bear watching its sole cub. The balance sheet is clearly the area to focus on when you are analysing debt. But it is future earnings, more than anything, that will determine Ingredion's ability to maintain a healthy balance sheet going forward. 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. So the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. Looking at the most recent three years, Ingredion recorded free cash flow of 32% of its EBIT, which is weaker than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.
Our View
Ingredion's EBIT growth rate and conversion of EBIT to free cash flow definitely weigh on it, in our esteem. But we do take some comfort from its interest cover. When we consider all the factors discussed, it seems to us that Ingredion is taking some risks with its use of debt. So while that leverage does boost returns on equity, we wouldn't really want to see it increase from here. 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. Be aware that Ingredion is showing 2 warning signs in our investment analysis , and 1 of those is a bit concerning...
If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.
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