These 4 Measures Indicate That Seneca Foods (NASDAQ:SENE.A) Is Using Debt Reasonably Well

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. As with many other companies Seneca Foods Corporation (NASDAQ:SENE.A) makes use of debt. But the real question is whether this debt is making the company risky.

Why Does Debt Bring Risk?

Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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. 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.

See our latest analysis for Seneca Foods

How Much Debt Does Seneca Foods Carry?

The image below, which you can click on for greater detail, shows that Seneca Foods had debt of US$172.2m at the end of September 2020, a reduction from US$244.0m over a year. On the flip side, it has US$14.8m in cash leading to net debt of about US$157.4m.

How Healthy Is Seneca Foods's Balance Sheet?

The latest balance sheet data shows that Seneca Foods had liabilities of US$380.6m due within a year, and liabilities of US$254.1m falling due after that. Offsetting this, it had US$14.8m in cash and US$134.8m in receivables that were due within 12 months. So its liabilities total US$485.1m more than the combination of its cash and short-term receivables.

Given this deficit is actually higher than the company's market capitalization of US$372.0m, we think shareholders really should watch Seneca Foods's debt levels, like a parent watching their child ride a bike for the first time. Hypothetically, extremely heavy dilution would be required if the company were forced to pay down its liabilities by raising capital at the current share price.

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).

Seneca Foods's net debt is only 1.1 times its EBITDA. And its EBIT covers its interest expense a whopping 13.8 times over. So we're pretty relaxed about its super-conservative use of debt. Although Seneca Foods made a loss at the EBIT level, last year, it was also good to see that it generated US$115m in EBIT over the last twelve months. There's no doubt that we learn most about debt from the balance sheet. But it is Seneca Foods's earnings that will influence how the balance sheet holds up in the future. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So it is important to check how much of its earnings before interest and tax (EBIT) converts to actual free cash flow. Over the most recent year, Seneca Foods recorded free cash flow worth 79% 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

Seneca Foods's interest cover was a real positive on this analysis, as was its conversion of EBIT to free cash flow. But truth be told its level of total liabilities had us nibbling our nails. Looking at all this data makes us feel a little cautious about Seneca Foods's debt levels. While we appreciate debt can enhance returns on equity, we'd suggest that shareholders keep close watch on its debt levels, lest they increase. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. Be aware that Seneca Foods is showing 1 warning sign in our investment analysis , you should know about...

At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.

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