Here's Why Associated British Foods (LON:ABF) Can Manage Its Debt Responsibly

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.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. Importantly, Associated British Foods plc (LON:ABF) does carry debt. But the more important question is: how much risk is that debt creating?

When Is Debt A Problem?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. When we think about a company's use of debt, we first look at cash and debt together.

View our latest analysis for Associated British Foods

What Is Associated British Foods's Debt?

You can click the graphic below for the historical numbers, but it shows that Associated British Foods had UK£630.0m of debt in March 2023, down from UK£748.0m, one year before. But it also has UK£1.22b in cash to offset that, meaning it has UK£586.0m net cash.

How Healthy Is Associated British Foods' Balance Sheet?

The latest balance sheet data shows that Associated British Foods had liabilities of UK£3.72b due within a year, and liabilities of UK£4.04b falling due after that. Offsetting these obligations, it had cash of UK£1.22b as well as receivables valued at UK£1.89b due within 12 months. So its liabilities total UK£4.66b more than the combination of its cash and short-term receivables.

While this might seem like a lot, it is not so bad since Associated British Foods has a huge market capitalization of UK£15.2b, and so it could probably strengthen its balance sheet by raising capital if it needed to. However, it is still worthwhile taking a close look at its ability to pay off debt. While it does have liabilities worth noting, Associated British Foods also has more cash than debt, so we're pretty confident it can manage its debt safely.

Fortunately, Associated British Foods grew its EBIT by 3.6% in the last year, making that debt load look even more manageable. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately the future profitability of the business will decide if Associated British 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.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. While Associated British 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, Associated British Foods produced sturdy free cash flow equating to 58% of its EBIT, about what we'd expect. This cold hard cash means it can reduce its debt when it wants to.

Summing Up

Although Associated British Foods's balance sheet isn't particularly strong, due to the total liabilities, it is clearly positive to see that it has net cash of UK£586.0m. So we are not troubled with Associated British Foods's debt use. Above most other metrics, we think its important to track how fast earnings per share is growing, if at all. If you've also come to that realization, you're in luck, because today you can view this interactive graph of Associated British Foods's earnings per share history 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.

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This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. 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.