Is TreeHouse Foods (NYSE:THS) Using Too Much Debt?

David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the 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. As with many other companies TreeHouse Foods, Inc. (NYSE:THS) makes use of debt. But should shareholders be worried about its use of debt?

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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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. When we examine debt levels, we first consider both cash and debt levels, together.

See our latest analysis for TreeHouse Foods

What Is TreeHouse Foods's Debt?

As you can see below, TreeHouse Foods had US$1.40b of debt at June 2024, down from US$1.59b a year prior. However, because it has a cash reserve of US$119.4m, its net debt is less, at about US$1.28b.

A Look At TreeHouse Foods' Liabilities

Zooming in on the latest balance sheet data, we can see that TreeHouse Foods had liabilities of US$645.7m due within 12 months and liabilities of US$1.71b due beyond that. On the other hand, it had cash of US$119.4m and US$186.2m worth of receivables due within a year. So its liabilities total US$2.05b more than the combination of its cash and short-term receivables.

When you consider that this deficiency exceeds the company's US$1.93b market capitalization, you might well be inclined to review the balance sheet intently. In the scenario where the company had to clean up its balance sheet quickly, it seems likely shareholders would suffer extensive 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). 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).

While TreeHouse Foods's debt to EBITDA ratio (4.4) suggests that it uses some debt, its interest cover is very weak, at 2.3, suggesting high leverage. So shareholders should probably be aware that interest expenses appear to have really impacted the business lately. Even worse, TreeHouse Foods saw its EBIT tank 26% over the last 12 months. If earnings continue to follow that trajectory, paying off that debt load will be harder than convincing us to run a marathon in the rain. 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 TreeHouse Foods can strengthen its balance sheet over time. 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 it's worth checking how much of that EBIT is backed by free cash flow. In the last three years, TreeHouse Foods basically broke even on a free cash flow basis. Some might say that's a concern, when it comes considering how easily it would be for it to down debt.

Our View

We'd go so far as to say TreeHouse Foods's EBIT growth rate was disappointing. And furthermore, its net debt to EBITDA also fails to instill confidence. After considering the datapoints discussed, we think TreeHouse Foods has too much debt. While some investors love that sort of risky play, it's certainly not our cup of tea. Given our concerns about TreeHouse Foods's debt levels, it seems only prudent to check if insiders have been ditching the stock.

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.