These 4 Measures Indicate That Kraft Heinz (NASDAQ:KHC) Is Using Debt Extensively

David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the permanent loss of capital.' 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. As with many other companies The Kraft Heinz Company (NASDAQ:KHC) makes use of debt. But the more important question is: how much risk is that debt creating?

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. If things get really bad, the lenders can take control of the business. 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. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. When we think about a company's use of debt, we first look at cash and debt together.

Check out our latest analysis for Kraft Heinz

What Is Kraft Heinz's Debt?

You can click the graphic below for the historical numbers, but it shows that Kraft Heinz had US$20.0b of debt in December 2022, down from US$21.9b, one year before. However, it does have US$1.04b in cash offsetting this, leading to net debt of about US$19.0b.

How Strong Is Kraft Heinz's Balance Sheet?

According to the last reported balance sheet, Kraft Heinz had liabilities of US$9.03b due within 12 months, and liabilities of US$32.6b due beyond 12 months. On the other hand, it had cash of US$1.04b and US$2.12b worth of receivables due within a year. So its liabilities total US$38.5b more than the combination of its cash and short-term receivables.

This deficit is considerable relative to its very significant market capitalization of US$48.0b, so it does suggest shareholders should keep an eye on Kraft Heinz's use of debt. Should its lenders demand that it shore up the balance sheet, shareholders would likely face severe dilution.

In order to size up a company's debt relative to its earnings, we calculate its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and its earnings before interest and tax (EBIT) divided by its interest expense (its interest cover). 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).

Kraft Heinz has a debt to EBITDA ratio of 3.2 and its EBIT covered its interest expense 5.7 times. Taken together this implies that, while we wouldn't want to see debt levels rise, we think it can handle its current leverage. Unfortunately, Kraft Heinz saw its EBIT slide 7.0% in the last twelve months. If that earnings trend continues then its debt load will grow heavy like the heart of a polar bear watching its sole cub. There's no doubt that we learn most about debt from the balance sheet. But it is future earnings, more than anything, that will determine Kraft Heinz'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, Kraft Heinz 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.

Our View

Neither Kraft Heinz's ability to handle its total liabilities nor its EBIT growth rate gave us confidence in its ability to take on more debt. But it seems to be able to convert EBIT to free cash flow without much trouble. When we consider all the factors discussed, it seems to us that Kraft Heinz 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. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. For example, we've discovered 3 warning signs for Kraft Heinz that you should be aware of before investing here.

If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.

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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.