Is Sealed Air (NYSE:SEE) A Risky Investment?

Warren Buffett famously said, 'Volatility is far from synonymous with risk.' 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 note that Sealed Air Corporation (NYSE:SEE) 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. If things get really bad, the lenders can take control of the business. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. The first step when considering a company's debt levels is to consider its cash and debt together.

See our latest analysis for Sealed Air

What Is Sealed Air's Debt?

As you can see below, Sealed Air had US$3.61b of debt at September 2022, down from US$3.77b a year prior. However, it also had US$248.8m in cash, and so its net debt is US$3.36b.

How Healthy Is Sealed Air's Balance Sheet?

We can see from the most recent balance sheet that Sealed Air had liabilities of US$1.88b falling due within a year, and liabilities of US$3.98b due beyond that. Offsetting this, it had US$248.8m in cash and US$754.2m in receivables that were due within 12 months. So its liabilities total US$4.85b more than the combination of its cash and short-term receivables.

This deficit is considerable relative to its market capitalization of US$7.59b, so it does suggest shareholders should keep an eye on Sealed Air's use of debt. Should its lenders demand that it shore up the balance sheet, shareholders would likely face severe dilution.

In order to size up a company's debt relative to its earnings, we calculate its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and its earnings before interest and tax (EBIT) divided by its interest expense (its interest cover). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

Sealed Air's debt is 2.9 times its EBITDA, and its EBIT cover its interest expense 6.2 times over. Taken together this implies that, while we wouldn't want to see debt levels rise, we think it can handle its current leverage. If Sealed Air can keep growing EBIT at last year's rate of 20% over the last year, then it will find its debt load easier to manage. 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 Sealed Air 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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So it's worth checking how much of that EBIT is backed by free cash flow. Over the most recent three years, Sealed Air recorded free cash flow worth 53% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This cold hard cash means it can reduce its debt when it wants to.

Our View

On our analysis Sealed Air's EBIT growth rate should signal that it won't have too much trouble with its debt. But the other factors we noted above weren't so encouraging. For instance it seems like it has to struggle a bit to handle its total liabilities. Looking at all this data makes us feel a little cautious about Sealed Air's debt levels. While debt does have its upside in higher potential returns, we think shareholders should definitely consider how debt levels might make the stock more risky. 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 1 warning sign for Sealed Air you should be aware of.

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.

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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.