These 4 Measures Indicate That Hostess Brands (NASDAQ:TWNK) Is Using Debt Reasonably Well

By
Simply Wall St
Published
October 24, 2021
NasdaqCM:TWNK
Source: Shutterstock

Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk.' 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. Importantly, Hostess Brands, Inc. (NASDAQ:TWNK) does carry debt. But the real question is whether this debt is making the company risky.

When Is Debt Dangerous?

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. If things get really bad, the lenders can take control of the business. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. 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 examine debt levels, we first consider both cash and debt levels, together.

Check out our latest analysis for Hostess Brands

What Is Hostess Brands's Net Debt?

The chart below, which you can click on for greater detail, shows that Hostess Brands had US$1.10b in debt in June 2021; about the same as the year before. However, it does have US$218.8m in cash offsetting this, leading to net debt of about US$880.3m.

debt-equity-history-analysis
NasdaqCM:TWNK Debt to Equity History October 25th 2021

How Healthy Is Hostess Brands' Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Hostess Brands had liabilities of US$185.3m due within 12 months and liabilities of US$1.56b due beyond that. On the other hand, it had cash of US$218.8m and US$148.7m worth of receivables due within a year. So it has liabilities totalling US$1.37b more than its cash and near-term receivables, combined.

Hostess Brands has a market capitalization of US$2.44b, so it could very likely raise cash to ameliorate 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 use two main ratios to inform us about debt levels relative to earnings. The first is net debt divided by earnings before interest, tax, depreciation, and amortization (EBITDA), while the second is how many times its earnings before interest and tax (EBIT) covers its interest expense (or its interest cover, for short). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

Hostess Brands's debt is 3.3 times its EBITDA, and its EBIT cover its interest expense 5.4 times over. Taken together this implies that, while we wouldn't want to see debt levels rise, we think it can handle its current leverage. Importantly, Hostess Brands grew its EBIT by 71% over the last twelve months, and that growth will make it easier to handle its debt. The balance sheet is clearly the area to focus on when you are analysing debt. But it is future earnings, more than anything, that will determine Hostess Brands'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, Hostess Brands 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

On our analysis Hostess Brands's EBIT growth rate should signal that it won't have too much trouble with its debt. However, our other observations weren't so heartening. For example, its net debt to EBITDA makes us a little nervous about its debt. Considering this range of data points, we think Hostess Brands is in a good position to manage its debt levels. Having said that, the load is sufficiently heavy that we would recommend any shareholders keep a close eye on it. 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. We've identified 2 warning signs with Hostess Brands (at least 1 which is potentially serious) , and understanding them should be part of your investment process.

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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