Is H.B. Fuller (NYSE:FUL) Using Too Much Debt?

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 H.B. Fuller Company (NYSE:FUL) does use debt in its business. But the more important question is: how much risk is that debt creating?

What Risk Does Debt Bring?

Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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.

Check out our latest analysis for H.B. Fuller

How Much Debt Does H.B. Fuller Carry?

The image below, which you can click on for greater detail, shows that at December 2022 H.B. Fuller had debt of US$1.81b, up from US$1.63b in one year. However, because it has a cash reserve of US$79.9m, its net debt is less, at about US$1.73b.

A Look At H.B. Fuller's Liabilities

The latest balance sheet data shows that H.B. Fuller had liabilities of US$705.7m due within a year, and liabilities of US$2.15b falling due after that. On the other hand, it had cash of US$79.9m and US$643.7m worth of receivables due within a year. So its liabilities total US$2.13b more than the combination of its cash and short-term receivables.

While this might seem like a lot, it is not so bad since H.B. Fuller has a market capitalization of US$3.88b, and so it could probably strengthen its balance sheet by raising capital if it needed to. However, it is still worthwhile taking a close look at its ability to pay off debt.

We use two main ratios to inform us about debt levels relative to earnings. The first is net debt divided by earnings before interest, tax, depreciation, and amortization (EBITDA), while the second is how many times its earnings before interest and tax (EBIT) covers its interest expense (or its interest cover, for short). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

H.B. Fuller has a debt to EBITDA ratio of 3.5 and its EBIT covered its interest expense 3.6 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 the other hand, H.B. Fuller grew its EBIT by 21% in the last year. If sustained, this growth should make that debt evaporate like a scarce drinking water during an unnaturally hot summer. There's no doubt that we learn most about debt from the balance sheet. But ultimately the future profitability of the business will decide if H.B. Fuller can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So we always check how much of that EBIT is translated into free cash flow. Over the most recent three years, H.B. Fuller recorded free cash flow worth 54% 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

When it comes to the balance sheet, the standout positive for H.B. Fuller was the fact that it seems able to grow its EBIT confidently. But the other factors we noted above weren't so encouraging. For example, its interest cover makes us a little nervous about its debt. When we consider all the factors mentioned above, we do feel a bit cautious about H.B. Fuller's use of debt. While we appreciate debt can enhance returns on equity, we'd suggest that shareholders keep close watch on its debt levels, lest they increase. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. Case in point: We've spotted 2 warning signs for H.B. Fuller you should be aware of, and 1 of them is a bit unpleasant.

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.