We Think Tootsie Roll Industries (NYSE:TR) Can Stay On Top Of Its Debt
The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. Importantly, Tootsie Roll Industries, Inc. (NYSE:TR) does carry debt. But the more important question is: how much risk is that debt creating?
When Is Debt Dangerous?
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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. The first step when considering a company's debt levels is to consider its cash and debt together.
View our latest analysis for Tootsie Roll Industries
What Is Tootsie Roll Industries's Debt?
The chart below, which you can click on for greater detail, shows that Tootsie Roll Industries had US$8.43m in debt in September 2020; about the same as the year before. However, it does have US$166.5m in cash offsetting this, leading to net cash of US$158.1m.
How Healthy Is Tootsie Roll Industries' Balance Sheet?
We can see from the most recent balance sheet that Tootsie Roll Industries had liabilities of US$78.1m falling due within a year, and liabilities of US$143.2m due beyond that. Offsetting these obligations, it had cash of US$166.5m as well as receivables valued at US$70.0m due within 12 months. So it actually has US$15.2m more liquid assets than total liabilities.
Having regard to Tootsie Roll Industries' size, it seems that its liquid assets are well balanced with its total liabilities. So it's very unlikely that the US$2.72b company is short on cash, but still worth keeping an eye on the balance sheet. Simply put, the fact that Tootsie Roll Industries has more cash than debt is arguably a good indication that it can manage its debt safely.
But the other side of the story is that Tootsie Roll Industries saw its EBIT decline by 8.1% over the last year. That sort of decline, if sustained, will obviously make debt harder to handle. There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since Tootsie Roll Industries will need earnings to service that debt. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.
Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. While Tootsie Roll Industries has net cash on its balance sheet, it's still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. During the last three years, Tootsie Roll Industries generated free cash flow amounting to a very robust 83% of its EBIT, more than we'd expect. That positions it well to pay down debt if desirable to do so.
Summing up
While we empathize with investors who find debt concerning, you should keep in mind that Tootsie Roll Industries has net cash of US$158.1m, as well as more liquid assets than liabilities. And it impressed us with free cash flow of US$71m, being 83% of its EBIT. So we don't think Tootsie Roll Industries's use of debt is risky. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. These risks can be hard to spot. Every company has them, and we've spotted 2 warning signs for Tootsie Roll Industries (of which 1 is a bit unpleasant!) you should know about.
When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.
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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