These 4 Measures Indicate That Lamb Weston Holdings (NYSE:LW) Is Using Debt Reasonably Well

Simply Wall St · 09/29 14:19

Warren Buffett famously said, 'Volatility is far from synonymous with risk.' 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. Importantly, Lamb Weston Holdings, Inc. (NYSE:LW) does carry debt. But the real question is whether this debt is making the company risky.

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 frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. Of course, plenty of companies use debt to fund growth, without any negative consequences. The first step when considering a company's debt levels is to consider its cash and debt together.

See our latest analysis for Lamb Weston Holdings

What Is Lamb Weston Holdings's Debt?

As you can see below, at the end of May 2024, Lamb Weston Holdings had US$3.82b of debt, up from US$3.45b a year ago. Click the image for more detail. Net debt is about the same, since the it doesn't have much cash.

debt-equity-history-analysis
NYSE:LW Debt to Equity History September 29th 2024

A Look At Lamb Weston Holdings' Liabilities

The latest balance sheet data shows that Lamb Weston Holdings had liabilities of US$1.62b due within a year, and liabilities of US$3.96b falling due after that. Offsetting these obligations, it had cash of US$71.4m as well as receivables valued at US$743.6m due within 12 months. So its liabilities total US$4.76b more than the combination of its cash and short-term receivables.

While this might seem like a lot, it is not so bad since Lamb Weston Holdings has a market capitalization of US$9.60b, 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 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). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

Lamb Weston Holdings has net debt to EBITDA of 2.7 suggesting it uses a fair bit of leverage to boost returns. But the high interest coverage of 8.2 suggests it can easily service that debt. Also relevant is that Lamb Weston Holdings has grown its EBIT by a very respectable 28% in the last year, thus enhancing its ability to pay down debt. There's no doubt that we learn most about debt from the balance sheet. But it is future earnings, more than anything, that will determine Lamb Weston Holdings's ability to maintain a healthy balance sheet going forward. 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 it's worth checking how much of that EBIT is backed by free cash flow. Over the last three years, Lamb Weston Holdings reported free cash flow worth 4.2% of its EBIT, which is really quite low. That limp level of cash conversion undermines its ability to manage and pay down debt.

Our View

When it comes to the balance sheet, the standout positive for Lamb Weston Holdings was the fact that it seems able to grow its EBIT confidently. However, our other observations weren't so heartening. In particular, conversion of EBIT to free cash flow gives us cold feet. Looking at all this data makes us feel a little cautious about Lamb Weston Holdings'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. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. For instance, we've identified 3 warning signs for Lamb Weston Holdings that you should be aware of.

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.