PepsiCo (NASDAQ:PEP) Has A Pretty Healthy Balance Sheet

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. As with many other companies PepsiCo, Inc. (NASDAQ:PEP) makes use of debt. But the real question is whether this debt is making the company risky.

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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

View our latest analysis for PepsiCo

What Is PepsiCo's Net Debt?

You can click the graphic below for the historical numbers, but it shows that as of September 2023 PepsiCo had US$44.8b of debt, an increase on US$39.2b, over one year. However, because it has a cash reserve of US$10.3b, its net debt is less, at about US$34.5b.

How Strong Is PepsiCo's Balance Sheet?

The latest balance sheet data shows that PepsiCo had liabilities of US$32.7b due within a year, and liabilities of US$48.3b falling due after that. Offsetting this, it had US$10.3b in cash and US$11.8b in receivables that were due within 12 months. So it has liabilities totalling US$58.9b more than its cash and near-term receivables, combined.

This deficit isn't so bad because PepsiCo is worth a massive US$232.5b, 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.

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). 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 24.5 times, makes us even more comfortable. We saw PepsiCo grow its EBIT by 5.9% in the last twelve months. Whilst that hardly knocks our socks off it is a positive when it comes to debt. 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 PepsiCo 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, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. During the last three years, PepsiCo produced sturdy free cash flow equating to 53% of its EBIT, about what we'd expect. 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 conversion of EBIT to free cash flow is good too. Looking at all the aforementioned factors together, it strikes us that PepsiCo can handle its debt fairly comfortably. 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. However, not all investment risk resides within the balance sheet - far from it. Case in point: We've spotted 3 warning signs for PepsiCo you should be aware of.

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

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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.