Is Tootsie Roll Industries (NYSE:TR) Using Too Much Debt?

The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says '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, Tootsie Roll Industries, Inc. (NYSE:TR) does carry debt. But is this debt a concern to shareholders?

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. 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, 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. The first step when considering a company's debt levels is to consider its cash and debt together.

See our latest analysis for Tootsie Roll Industries

How Much Debt Does Tootsie Roll Industries Carry?

The chart below, which you can click on for greater detail, shows that Tootsie Roll Industries had US$8.44m in debt in December 2021; about the same as the year before. But on the other hand it also has US$145.8m in cash, leading to a US$137.4m net cash position.

How Strong Is Tootsie Roll Industries' Balance Sheet?

We can see from the most recent balance sheet that Tootsie Roll Industries had liabilities of US$80.0m falling due within a year, and liabilities of US$169.9m due beyond that. On the other hand, it had cash of US$145.8m and US$58.2m worth of receivables due within a year. So its liabilities total US$45.8m more than the combination of its cash and short-term receivables.

Having regard to Tootsie Roll Industries' size, it seems that its liquid assets are well balanced with its total liabilities. So while it's hard to imagine that the US$2.32b company is struggling for cash, we still think it's worth monitoring its balance sheet. 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 company can only pay off debt with cold hard cash, not accounting profits. 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. During the last three years, Tootsie Roll Industries generated free cash flow amounting to a very robust 81% of its EBIT, more than we'd expect. That puts it in a very strong position to pay down debt.

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$137.4m. The cherry on top was that in converted 81% of that EBIT to free cash flow, bringing in US$54m. So is Tootsie Roll Industries's debt a risk? It doesn't seem so to us. 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. For example, we've discovered 1 warning sign for Tootsie Roll Industries that you should be aware of before investing here.

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.