Is PepsiCo (NASDAQ:PEP) A Risky Investment?

The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' 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 note that PepsiCo, Inc. (NASDAQ:PEP) does have debt on its balance sheet. But the real question is whether this debt is making the company risky.

Why Does Debt Bring Risk?

Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. If things get really bad, the lenders can take control of the business. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. 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.

View our latest analysis for PepsiCo

How Much Debt Does PepsiCo Carry?

As you can see below, at the end of December 2023, PepsiCo had US$44.1b of debt, up from US$39.1b a year ago. Click the image for more detail. On the flip side, it has US$10.0b in cash leading to net debt of about US$34.1b.

How Healthy Is PepsiCo's Balance Sheet?

The latest balance sheet data shows that PepsiCo had liabilities of US$31.6b due within a year, and liabilities of US$50.2b falling due after that. Offsetting these obligations, it had cash of US$10.0b as well as receivables valued at US$10.8b due within 12 months. So it has liabilities totalling US$61.0b more than its cash and near-term receivables, combined.

This deficit isn't so bad because PepsiCo is worth a massive US$242.5b, and thus could probably raise enough capital to shore up its balance sheet, if the need arose. But it's clear that we should definitely closely examine whether it can manage its debt without dilution.

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). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

PepsiCo's net debt to EBITDA ratio of about 2.1 suggests only moderate use of debt. And its strong interest cover of 15.8 times, makes us even more comfortable. If PepsiCo can keep growing EBIT at last year's rate of 10% over the last year, then it will find its debt load easier to manage. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine PepsiCo'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. Over the most recent three years, PepsiCo recorded free cash flow worth 55% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This free cash flow puts the company in a good position to pay down debt, when appropriate.

Our View

Happily, PepsiCo's impressive interest cover implies it has the upper hand on its debt. And its EBIT growth rate is good too. All these things considered, it appears that PepsiCo can comfortably handle its current debt levels. Of course, while this leverage can enhance returns on equity, it does bring more risk, so it's worth keeping an eye on this one. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. For example, we've discovered 2 warning signs for PepsiCo 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.