Is Tootsie Roll Industries (NYSE:TR) A Risky Investment?

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. We can see that Tootsie Roll Industries, Inc. (NYSE:TR) does use debt in its business. But is this debt a concern to shareholders?

Why Does Debt Bring Risk?

Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. 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. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. The first step when considering a company's debt levels is to consider its cash and debt together.

View our latest analysis for Tootsie Roll Industries

What Is Tootsie Roll Industries's Debt?

The chart below, which you can click on for greater detail, shows that Tootsie Roll Industries had US$8.52m in debt in June 2022; about the same as the year before. But it also has US$123.1m in cash to offset that, meaning it has US$114.6m net cash.

A Look At Tootsie Roll Industries' Liabilities

According to the last reported balance sheet, Tootsie Roll Industries had liabilities of US$82.5m due within 12 months, and liabilities of US$149.6m due beyond 12 months. On the other hand, it had cash of US$123.1m and US$48.7m worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by US$60.3m.

Of course, Tootsie Roll Industries has a market capitalization of US$2.41b, so these liabilities are probably manageable. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time. While it does have liabilities worth noting, Tootsie Roll Industries also has more cash than debt, so we're pretty confident it can manage its debt safely.

And we also note warmly that Tootsie Roll Industries grew its EBIT by 15% last year, making its debt load easier to handle. There's no doubt that we learn most about debt from the balance sheet. But it is Tootsie Roll Industries'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, a business needs free cash flow to pay off debt; accounting profits just don't cut it. Tootsie Roll Industries may have net cash on the balance sheet, but it is still interesting to look at how well the business converts its earnings before interest and tax (EBIT) to free cash flow, because that will influence both its need for, and its capacity to manage debt. Over the most recent three years, Tootsie Roll Industries recorded free cash flow worth 75% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This cold hard cash means it can reduce its debt when it wants to.

Summing Up

We could understand if investors are concerned about Tootsie Roll Industries's liabilities, but we can be reassured by the fact it has has net cash of US$114.6m. The cherry on top was that in converted 75% of that EBIT to free cash flow, bringing in US$46m. So we don't think Tootsie Roll Industries's use of debt is risky. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. Be aware that Tootsie Roll Industries 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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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.