These 4 Measures Indicate That Packaging Corporation of America (NYSE:PKG) Is Using Debt Reasonably Well

Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' So it seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. Importantly, Packaging Corporation of America (NYSE:PKG) does carry debt. But the real question is whether this debt is making the company risky.

When Is Debt A Problem?

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. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

View our latest analysis for Packaging Corporation of America

What Is Packaging Corporation of America's Debt?

You can click the graphic below for the historical numbers, but it shows that Packaging Corporation of America had US$2.47b of debt in December 2024, down from US$2.87b, one year before. However, because it has a cash reserve of US$787.0m, its net debt is less, at about US$1.69b.

How Strong Is Packaging Corporation of America's Balance Sheet?

The latest balance sheet data shows that Packaging Corporation of America had liabilities of US$1.00b due within a year, and liabilities of US$3.43b falling due after that. Offsetting these obligations, it had cash of US$787.0m as well as receivables valued at US$1.15b due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by US$2.49b.

Of course, Packaging Corporation of America has a titanic market capitalization of US$17.5b, so these liabilities are probably manageable. But there are sufficient liabilities that we would certainly recommend shareholders continue to monitor the balance sheet, going forward.

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). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

Packaging Corporation of America's net debt is only 1.0 times its EBITDA. And its EBIT easily covers its interest expense, being 27.9 times the size. So we're pretty relaxed about its super-conservative use of debt. The good news is that Packaging Corporation of America has increased its EBIT by 3.0% over twelve months, which should ease any concerns about debt repayment. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately the future profitability of the business will decide if Packaging Corporation of America 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 clearly need to look at whether that EBIT is leading to corresponding free cash flow. During the last three years, Packaging Corporation of America produced sturdy free cash flow equating to 54% of its EBIT, about what we'd expect. This free cash flow puts the company in a good position to pay down debt, when appropriate.

Our View

Happily, Packaging Corporation of America's impressive interest cover implies it has the upper hand on its debt. And its net debt to EBITDA is good too. All these things considered, it appears that Packaging Corporation of America can comfortably handle its current debt levels. On the plus side, this leverage can boost shareholder returns, but the potential downside is more risk of loss, so it's worth monitoring the balance sheet. Of course, we wouldn't say no to the extra confidence that we'd gain if we knew that Packaging Corporation of America insiders have been buying shares: if you're on the same wavelength, you can find out if insiders are buying by clicking this link.

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

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.