These 4 Measures Indicate That International Flavors & Fragrances (NYSE:IFF) Is Using Debt Extensively

Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. We can see that International Flavors & Fragrances Inc. (NYSE:IFF) does use debt in its business. But should shareholders be worried about its use of debt?

What Risk Does Debt Bring?

Debt assists a business until the business has trouble paying it off, either with new capital or with free 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 frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. Of course, plenty of companies use debt to fund growth, without any negative consequences. The first step when considering a company's debt levels is to consider its cash and debt together.

View our latest analysis for International Flavors & Fragrances

What Is International Flavors & Fragrances's Debt?

As you can see below, International Flavors & Fragrances had US$11.3b of debt, at March 2023, which is about the same as the year before. You can click the chart for greater detail. However, because it has a cash reserve of US$606.0m, its net debt is less, at about US$10.7b.

How Healthy Is International Flavors & Fragrances' Balance Sheet?

The latest balance sheet data shows that International Flavors & Fragrances had liabilities of US$4.87b due within a year, and liabilities of US$12.7b falling due after that. On the other hand, it had cash of US$606.0m and US$1.90b worth of receivables due within a year. So it has liabilities totalling US$15.1b more than its cash and near-term receivables, combined.

This is a mountain of leverage even relative to its gargantuan market capitalization of US$21.2b. Should its lenders demand that it shore up the balance sheet, shareholders would likely face severe dilution.

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). 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).

Weak interest cover of 2.4 times and a disturbingly high net debt to EBITDA ratio of 5.2 hit our confidence in International Flavors & Fragrances like a one-two punch to the gut. This means we'd consider it to have a heavy debt load. Worse, International Flavors & Fragrances's EBIT was down 44% over the last year. 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. There's no doubt that we learn most about debt from the balance sheet. But it is future earnings, more than anything, that will determine International Flavors & Fragrances's ability to maintain a healthy balance sheet going forward. 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 it's worth checking how much of that EBIT is backed by free cash flow. Looking at the most recent three years, International Flavors & Fragrances recorded free cash flow of 47% of its EBIT, which is weaker than we'd expect. That's not great, when it comes to paying down debt.

Our View

On the face of it, International Flavors & Fragrances's net debt to EBITDA left us tentative about the stock, and its EBIT growth rate was no more enticing than the one empty restaurant on the busiest night of the year. Having said that, its ability to convert EBIT to free cash flow isn't such a worry. We're quite clear that we consider International Flavors & Fragrances to be really rather risky, as a result of its balance sheet health. For this reason we're pretty cautious about the stock, and we think shareholders should keep a close eye on its liquidity. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. For instance, we've identified 3 warning signs for International Flavors & Fragrances (2 are a bit concerning) you should be aware of.

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.