Stock Analysis

Hershey (NYSE:HSY) Seems To Use Debt Quite Sensibly

NYSE:HSY
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Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a 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. Importantly, The Hershey Company (NYSE:HSY) does carry debt. But the real question is whether this debt is making the company risky.

Why Does Debt Bring Risk?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. The first step when considering a company's debt levels is to consider its cash and debt together.

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How Much Debt Does Hershey Carry?

You can click the graphic below for the historical numbers, but it shows that Hershey had US$4.72b of debt in December 2022, down from US$4.96b, one year before. However, it does have US$463.9m in cash offsetting this, leading to net debt of about US$4.25b.

debt-equity-history-analysis
NYSE:HSY Debt to Equity History March 13th 2023

A Look At Hershey's Liabilities

We can see from the most recent balance sheet that Hershey had liabilities of US$3.26b falling due within a year, and liabilities of US$4.39b due beyond that. On the other hand, it had cash of US$463.9m and US$711.2m worth of receivables due within a year. So it has liabilities totalling US$6.47b more than its cash and near-term receivables, combined.

Given Hershey has a humongous market capitalization of US$48.5b, it's hard to believe these liabilities pose much threat. Having said that, it's clear that we should continue to monitor its balance sheet, lest it change for the worse.

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.

Hershey's net debt to EBITDA ratio of about 1.6 suggests only moderate use of debt. And its commanding EBIT of 16.4 times its interest expense, implies the debt load is as light as a peacock feather. Fortunately, Hershey grew its EBIT by 9.5% in the last year, making that debt load look even more manageable. 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 Hershey'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, a business needs free cash flow to pay off debt; accounting profits just don't cut it. So we always check how much of that EBIT is translated into free cash flow. Over the most recent three years, Hershey recorded free cash flow worth 76% 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

Hershey's interest cover suggests it can handle its debt as easily as Cristiano Ronaldo could score a goal against an under 14's goalkeeper. And that's just the beginning of the good news since its conversion of EBIT to free cash flow is also very heartening. Zooming out, Hershey seems to use debt quite reasonably; and that gets the nod from us. While debt does bring risk, when used wisely it can also bring a higher return on equity. 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. Be aware that Hershey is showing 1 warning sign in our investment analysis , you should know about...

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

Valuation is complex, but we're here to simplify it.

Discover if Hershey might be undervalued or overvalued with our detailed analysis, featuring fair value estimates, potential risks, dividends, insider trades, and its financial condition.

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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.