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 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. We can see that Tyson Foods, Inc. (NYSE:TSN) does use debt in its business. But the more important question is: how much risk is that debt creating?
Why Does Debt Bring Risk?
Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. 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. Of course, plenty of companies use debt to fund growth, without any negative consequences. When we think about a company’s use of debt, we first look at cash and debt together.
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What Is Tyson Foods’s Debt?
As you can see below, Tyson Foods had US$8.32b of debt at October 2022, down from US$9.35b a year prior. However, it also had US$1.03b in cash, and so its net debt is US$7.29b.
How Strong Is Tyson Foods’ Balance Sheet?
Zooming in on the latest balance sheet data, we can see that Tyson Foods had liabilities of US$5.31b due within 12 months and liabilities of US$11.7b due beyond that. On the other hand, it had cash of US$1.03b and US$2.58b worth of receivables due within a year. So it has liabilities totalling US$13.4b more than its cash and near-term receivables, combined.
While this might seem like a lot, it is not so bad since Tyson Foods has a huge market capitalization of US$23.0b, and so it could probably strengthen its balance sheet by raising capital if it needed to. But we definitely want to keep our eyes open to indications that its debt is bringing too much risk.
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). 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).
Tyson Foods has a low net debt to EBITDA ratio of only 1.3. And its EBIT easily covers its interest expense, being 12.7 times the size. So you could argue it is no more threatened by its debt than an elephant is by a mouse. While Tyson Foods doesn’t seem to have gained much on the EBIT line, at least earnings remain stable for now. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Tyson Foods 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.
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. During the last three years, Tyson Foods produced sturdy free cash flow equating to 51% of its EBIT, about what we’d expect. This cold hard cash means it can reduce its debt when it wants to.
Our View
When it comes to the balance sheet, the standout positive for Tyson Foods was the fact that it seems able to cover its interest expense with its EBIT confidently. But the other factors we noted above weren’t so encouraging. For example, its level of total liabilities makes us a little nervous about its debt. Looking at all this data makes us feel a little cautious about Tyson Foods’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. We’d be motivated to research the stock further if we found out that Tyson Foods insiders have bought shares recently. If you would too, then you’re in luck, since today we’re sharing our list of reported insider transactions for free.
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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Find out whether Tyson Foods is potentially over or undervalued by checking out our comprehensive analysis, which includes fair value estimates, risks and warnings, dividends, insider transactions and financial health.
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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.
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