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.' 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 note that H.B. Fuller Company (NYSE:FUL) does have debt on its balance sheet. But the more important question is: how much risk is that debt creating?
When Is Debt Dangerous?
Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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. The first step when considering a company's debt levels is to consider its cash and debt together.
How Much Debt Does H.B. Fuller Carry?
The chart below, which you can click on for greater detail, shows that H.B. Fuller had US$1.92b in debt in March 2023; about the same as the year before. On the flip side, it has US$125.5m in cash leading to net debt of about US$1.80b.
A Look At H.B. Fuller's Liabilities
We can see from the most recent balance sheet that H.B. Fuller had liabilities of US$643.2m falling due within a year, and liabilities of US$2.26b due beyond that. Offsetting these obligations, it had cash of US$125.5m as well as receivables valued at US$566.4m due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by US$2.21b.
This deficit is considerable relative to its market capitalization of US$3.61b, so it does suggest shareholders should keep an eye on H.B. Fuller's use of debt. This suggests shareholders would be heavily diluted if the company needed to shore up its balance sheet in a hurry.
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). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.
H.B. Fuller has a debt to EBITDA ratio of 3.6 and its EBIT covered its interest expense 3.2 times. Taken together this implies that, while we wouldn't want to see debt levels rise, we think it can handle its current leverage. On a slightly more positive note, H.B. Fuller grew its EBIT at 20% over the last year, further increasing its ability to manage debt. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if H.B. Fuller 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.
But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So we always check how much of that EBIT is translated into free cash flow. In the last three years, H.B. Fuller's free cash flow amounted to 48% of its EBIT, less than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.
H.B. Fuller's interest cover and net debt to EBITDA definitely weigh on it, in our esteem. But the good news is it seems to be able to grow its EBIT with ease. We think that H.B. Fuller's debt does make it a bit risky, after considering the aforementioned data points together. That's not necessarily a bad thing, since leverage can boost returns on equity, but it is something to be aware of. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. To that end, you should be aware of the 1 warning sign we've spotted with H.B. Fuller .
When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.
What are the risks and opportunities for H.B. Fuller?
Trading at 6.9% below our estimate of its fair value
Earnings are forecast to grow 19.07% per year
Interest payments are not well covered by earnings
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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.
H.B. Fuller Company, together with its subsidiaries, formulates, manufactures, and markets adhesives, sealants, coatings, polymers, tapes, encapsulants, additives, and other specialty chemical products worldwide.
Average dividend payer and slightly overvalued.