Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that ‘Volatility is far from synonymous with risk.’ 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. We can see that Sanderson Farms, Inc. (NASDAQ:SAFM) does use debt in its business. But should shareholders be worried about its use of debt?
When Is Debt A Problem?
Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. When we think about a company’s use of debt, we first look at cash and debt together.
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What Is Sanderson Farms’s Debt?
The image below, which you can click on for greater detail, shows that at July 2020 Sanderson Farms had debt of US$95.0m, up from US$30.0m in one year. However, it also had US$66.1m in cash, and so its net debt is US$28.9m.
How Strong Is Sanderson Farms’s Balance Sheet?
According to the last reported balance sheet, Sanderson Farms had liabilities of US$219.1m due within 12 months, and liabilities of US$270.2m due beyond 12 months. Offsetting these obligations, it had cash of US$66.1m as well as receivables valued at US$192.0m due within 12 months. So its liabilities total US$231.1m more than the combination of its cash and short-term receivables.
Since publicly traded Sanderson Farms shares are worth a total of US$2.61b, it seems unlikely that this level of liabilities would be a major threat. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time. Carrying virtually no net debt, Sanderson Farms has a very light debt load indeed. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Sanderson Farms’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.
In the last year Sanderson Farms wasn’t profitable at an EBIT level, but managed to grow its revenue by 5.9%, to US$3.5b. That rate of growth is a bit slow for our taste, but it takes all types to make a world.
Caveat Emptor
Over the last twelve months Sanderson Farms produced an earnings before interest and tax (EBIT) loss. Indeed, it lost US$62m at the EBIT level. When we look at that and recall the liabilities on its balance sheet, relative to cash, it seems unwise to us for the company to have any debt. So we think its balance sheet is a little strained, though not beyond repair. Another cause for caution is that is bled US$34m in negative free cash flow over the last twelve months. So suffice it to say we do consider the stock to be risky. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet – far from it. For instance, we’ve identified 1 warning sign for Sanderson Farms that 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.
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