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David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the permanent loss of capital.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. As with many other companies Seaboard Corporation (NYSEMKT:SEB) makes use of debt. But the real question is whether this debt is making the company risky.
When Is Debt Dangerous?
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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we examine debt levels, we first consider both cash and debt levels, together.
What Is Seaboard's Net Debt?
You can click the graphic below for the historical numbers, but it shows that Seaboard had US$984.0m of debt in December 2020, down from US$1.04b, one year before. But on the other hand it also has US$1.54b in cash, leading to a US$557.0m net cash position.
How Healthy Is Seaboard's Balance Sheet?
According to the last reported balance sheet, Seaboard had liabilities of US$1.08b due within 12 months, and liabilities of US$1.50b due beyond 12 months. Offsetting this, it had US$1.54b in cash and US$532.0m in receivables that were due within 12 months. So it has liabilities totalling US$498.0m more than its cash and near-term receivables, combined.
Given Seaboard has a market capitalization of US$4.18b, it's hard to believe these liabilities pose much threat. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time. Despite its noteworthy liabilities, Seaboard boasts net cash, so it's fair to say it does not have a heavy debt load!
Even more impressive was the fact that Seaboard grew its EBIT by 106% over twelve months. If maintained that growth will make the debt even more manageable in the years ahead. There's no doubt that we learn most about debt from the balance sheet. But it is Seaboard's earnings that will influence how the balance sheet holds up in the future. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.
But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. Seaboard may have net cash on the balance sheet, but it is still interesting to look at how well the business converts its earnings before interest and tax (EBIT) to free cash flow, because that will influence both its need for, and its capacity to manage debt. Considering the last three years, Seaboard actually recorded a cash outflow, overall. Debt is far more risky for companies with unreliable free cash flow, so shareholders should be hoping that the past expenditure will produce free cash flow in the future.
Although Seaboard's balance sheet isn't particularly strong, due to the total liabilities, it is clearly positive to see that it has net cash of US$557.0m. And we liked the look of last year's 106% year-on-year EBIT growth. So we are not troubled with Seaboard's debt use. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. Be aware that Seaboard is showing 1 warning sign in our investment analysis , you should know about...
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.
This article by Simply Wall St is general in nature. 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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