Warren Buffett famously said, '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. As with many other companies TreeHouse Foods, Inc. (NYSE:THS) makes use of debt. But is this debt a concern to shareholders?

When Is Debt A Problem?

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. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. When we examine debt levels, we first consider both cash and debt levels, together.

How Much Debt Does TreeHouse Foods Carry?

You can click the graphic below for the historical numbers, but it shows that TreeHouse Foods had US$1.40b of debt in June 2024, down from US$1.59b, one year before. However, because it has a cash reserve of US$119.4m, its net debt is less, at about US$1.28b.

A Look At TreeHouse Foods' Liabilities

According to the last reported balance sheet, TreeHouse Foods had liabilities of US$645.7m due within 12 months, and liabilities of US$1.71b due beyond 12 months. Offsetting this, it had US$119.4m in cash and US$186.2m in receivables that were due within 12 months. So it has liabilities totalling US$2.05b more than its cash and near-term receivables, combined.

This deficit is considerable relative to its market capitalization of US$2.22b, so it does suggest shareholders should keep an eye on TreeHouse Foods' use of debt. Should its lenders demand that it shore up the balance sheet, shareholders would likely face severe dilution.

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). 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).

While we wouldn't worry about TreeHouse Foods's net debt to EBITDA ratio of 4.4, we think its super-low interest cover of 2.3 times is a sign of high leverage. So shareholders should probably be aware that interest expenses appear to have really impacted the business lately. Even worse, TreeHouse Foods saw its EBIT tank 26% over the last 12 months. If earnings keep going like that over the long term, it has a snowball's chance in hell of paying off that debt. There's no doubt that we learn most about debt from the balance sheet. But ultimately the future profitability of the business will decide if TreeHouse Foods 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.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. So the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. In the last three years, TreeHouse Foods basically broke even on a free cash flow basis. Some might say that's a concern, when it comes considering how easily it would be for it to down debt.

Our View

Mulling over TreeHouse Foods's attempt at (not) growing its EBIT, we're certainly not enthusiastic. And even its net debt to EBITDA fails to inspire much confidence. Taking into account all the aforementioned factors, it looks like TreeHouse Foods has too much debt. That sort of riskiness is ok for some, but it certainly doesn't float our boat. Given the risks around TreeHouse Foods's use of debt, the sensible thing to do is to check if insiders have been unloading the stock.

At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.

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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.