Post Holdings (NYSE:POST) Takes On Some Risk With Its Use Of Debt

Simply Wall St · 03/25 11:01

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. Importantly, Post Holdings, Inc. (NYSE:POST) does carry debt. But should shareholders be worried about its use of debt?

Why Does Debt Bring Risk?

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. 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 examine debt levels, we first consider both cash and debt levels, together.

See our latest analysis for Post Holdings

What Is Post Holdings's Net Debt?

The image below, which you can click on for greater detail, shows that at December 2023 Post Holdings had debt of US$6.32b, up from US$5.93b in one year. However, because it has a cash reserve of US$157.3m, its net debt is less, at about US$6.17b.

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NYSE:POST Debt to Equity History March 25th 2024

A Look At Post Holdings' Liabilities

We can see from the most recent balance sheet that Post Holdings had liabilities of US$835.3m falling due within a year, and liabilities of US$7.28b due beyond that. On the other hand, it had cash of US$157.3m and US$583.2m worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by US$7.38b.

Given this deficit is actually higher than the company's market capitalization of US$6.41b, we think shareholders really should watch Post Holdings's debt levels, like a parent watching their child ride a bike for the first time. In the scenario where the company had to clean up its balance sheet quickly, it seems likely shareholders would suffer extensive 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). 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).

With a net debt to EBITDA ratio of 5.3, it's fair to say Post Holdings does have a significant amount of debt. However, its interest coverage of 2.6 is reasonably strong, which is a good sign. The good news is that Post Holdings grew its EBIT a smooth 40% over the last twelve months. Like a mother's loving embrace of a newborn that sort of growth builds resilience, putting the company in a stronger position to manage its 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 Post Holdings 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, a business needs free cash flow to pay off debt; accounting profits just don't cut it. So we always check how much of that EBIT is translated into free cash flow. Over the most recent three years, Post Holdings 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

Neither Post Holdings's ability handle its debt, based on its EBITDA, nor its interest cover gave us confidence in its ability to take on more debt. But the good news is it seems to be able to grow its EBIT with ease. Taking the abovementioned factors together we do think Post Holdings's debt poses some risks to the business. So while that leverage does boost returns on equity, we wouldn't really want to see it increase from here. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. We've identified 4 warning signs with Post Holdings (at least 1 which is a bit unpleasant) , and understanding them should be part of your investment process.

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.