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. 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, Hilton Food Group plc (LON:HFG) does carry debt. But the more important question is: how much risk is that debt creating?
When Is Debt Dangerous?
Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Part and parcel of capitalism is the process of ‘creative destruction’ where failed businesses are mercilessly liquidated by their bankers. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.
What Is Hilton Food Group’s Debt?
You can click the graphic below for the historical numbers, but it shows that as of December 2018 Hilton Food Group had UK£113.0m of debt, an increase on UK£53.3m, over one year. However, because it has a cash reserve of UK£88.0m, its net debt is less, at about UK£25.0m.
A Look At Hilton Food Group’s Liabilities
The latest balance sheet data shows that Hilton Food Group had liabilities of UK£280.3m due within a year, and liabilities of UK£115.5m falling due after that. Offsetting this, it had UK£88.0m in cash and UK£165.6m in receivables that were due within 12 months. So its liabilities total UK£142.2m more than the combination of its cash and short-term receivables.
Given Hilton Food Group has a market capitalization of UK£835.2m, it’s hard to believe these liabilities pose much threat. But there are sufficient liabilities that we would certainly recommend shareholders continue to monitor the balance sheet, going forward.
We use two main ratios to inform us about debt levels relative to earnings. The first is net debt divided by earnings before interest, tax, depreciation, and amortization (EBITDA), while the second is how many times its earnings before interest and tax (EBIT) covers its interest expense (or its interest cover, for short). The advantage of this approach is that we take into account both the absolute quantum of debt (with net debt to EBITDA) and the actual interest expenses associated with that debt (with its interest cover ratio).
Hilton Food Group has a low net debt to EBITDA ratio of only 0.39. And its EBIT covers its interest expense a whopping 13.9 times over. So we’re pretty relaxed about its super-conservative use of debt. Also positive, Hilton Food Group grew its EBIT by 22% in the last year, and that should make it easier to pay down debt, going forward. 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 Hilton Food Group’s ability to maintain a healthy balance sheet going forward. So if you’re focused on the future you can check out this free report showing analyst profit forecasts.
Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. During the last three years, Hilton Food Group produced sturdy free cash flow equating to 56% of its EBIT, about what we’d expect. This cold hard cash means it can reduce its debt when it wants to.
Hilton Food Group’s interest cover suggests it can handle its debt as easily as Cristiano Ronaldo could score a goal against an under 14’s goalkeeper. And the good news does not stop there, as its net debt to EBITDA also supports that impression! Zooming out, Hilton Food Group seems to use debt quite reasonably; and that gets the nod from us. After all, sensible leverage can boost returns on equity. We’d be motivated to research the stock further if we found out that Hilton Food Group insiders have bought shares recently. If you would too, then you’re in luck, since today we’re sharing our list of reported insider transactions for free.
When all is said and done, sometimes its easier to focus on companies that don’t even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.
We aim to bring you long-term focused research analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material.
If you spot an error that warrants correction, please contact the editor at email@example.com. 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. Simply Wall St has no position in the stocks mentioned. Thank you for reading.