Analyzing the company’s debt
Warren Buffett, a renowned investor, has highlighted that volatility and risk are not the same thing. Nevertheless, assessing a company’s balance sheet, especially its debt levels, remains crucial in determining its riskiness. The case of Pilgrim’s Pride Corporation serves as an ideal example since it relies on debt in its operations, raising questions about the associated risks. To evaluate the risks related to Pilgrim’s Pride’s debt, investors should examine the company’s debt-to-equity ratio, liquidity, and overall financial health, enabling them to make well-informed decisions about whether the rewards outweigh the risks.
Importance of debt and cash management
Debt can be vital for business expansion, but a company that cannot repay its lenders may fall under their control or even face bankruptcy. It is not unusual for indebted corporations to permanently dilute shareholders as lenders force them to raise capital at unfavorable prices. However, most companies manage their debt effectively and beneficially. A crucial factor in analyzing a company’s debt usage is considering its cash and debt collectively, which can provide a clear understanding of the company’s overall financial health and its ability to meet its obligations. Proper debt management allows businesses to expand and improve their creditworthiness, facilitating better terms for future borrowing.
Examining Pilgrim’s Pride’s debt situation
As of September 2023, Pilgrim’s Pride’s debt stood at US$3.70 billion, up from US$3.21 billion the previous year. The company held a cash reserve of US$899.5 million, resulting in net debt of approximately US$2.80 billion. This increase in debt is attributable to the company’s ongoing investments in facility expansions and acquisitions to strengthen their market position. However, the significant cash reserve suggests the company is relatively stable financially, with the potential to manage and possibly reduce its net debt over time.
Assessing short-term and long-term liabilities
Based on Pilgrim’s Pride’s most recent balance sheet, the company had liabilities of US$2.53 billion due within a year and US$4.31 billion due after that period. Against these liabilities were US$899.5 million in cash and US$1.27 billion in receivables due within a year. With these figures, Pilgrim’s Pride has total liabilities of US$4.66 billion, exceeding its cash and short-term receivables combined. Given its market capitalization of US$6.19 billion, shareholders might experience significant dilution if the company urgently needed to strengthen its balance sheet. Moreover, if Pilgrim’s Pride cannot generate adequate revenue or secure financing to manage its debt obligations, it may face financial instability, making it essential for investors to assess the company’s overall financial health and ability to navigate potential challenges.
Ratios to gauge debt relative to earnings
Two ratios are primarily used to determine debt levels relative to earnings: net debt divided by earnings before interest, tax, depreciation, and amortization (EBITDA) and the number of times earnings before interest and tax (EBIT) covers interest expenses (interest cover). Examining debt relative to earnings with and without depreciation and amortization expenses enables an effective evaluation of a company’s ability to manage and service its debt. Understanding these financial indicators helps both investors and management make informed decisions about the company’s current financial stability and future growth potential.
Analyzing Pilgrim’s Pride’s debt ratios
Pilgrim’s Pride’s debt to EBITDA ratio (3.7) indicates some debt usage, but its weak interest cover of 2.3 suggests high leverage. The company appears to have significant depreciation and amortization expenses, making its debt seem more burdensome than it actually is. Shareholders should be aware that interest expenses have substantially impacted the business recently, with high leverage exposing the company to potential financial risks, particularly in unstable economic conditions or sudden industry shifts. Investors should carefully consider these factors and analyze the company’s ability to manage its debt effectively to maintain stable operations and achieve sustainable growth.
Evaluating declining EBIT and future profitability
Furthermore, Pilgrim’s Pride’s EBIT has declined by 81% over the past year. If this downward trend in earnings persists, repaying its debt burden will become increasingly challenging. The company’s future profitability will determine whether it can improve its balance sheet in the long term. Investors should also closely monitor the company’s financial performance and strategic initiatives aimed at increasing profits, with a focus on a sustainable growth plan and efficient cost management to overcome current challenges and reduce the risk associated with high debt levels.
Examining EBIT and free cash flow
It is crucial to recognize that accounting profits might suffice for tax purposes, but lenders require actual cash. Therefore, examining the proportion of EBIT matched by real free cash flow is essential. In the past three years, Pilgrim’s Pride reported free cash flow equal to just 7.7% of its EBIT, a concerning low figure that raises doubts about its ability to repay debt. This low percentage suggests that a large portion of the company’s earnings is not being converted into available cash, possibly due to high capital expenditures, working capital requirements, or other factors. As a result, Pilgrim’s Pride may encounter challenges in meeting its debt obligations and maintaining a healthy financial position, potentially making it a riskier investment for both lenders and investors.
Perception of Pilgrim’s Pride’s financial risk
Due to its disappointing EBIT growth rate and its net debt to EBITDA ratio that does not inspire confidence, Pilgrim’s Pride is perceived as a high-risk company in terms of balance sheet health. This perception is further reinforced by the company’s recent struggles to maintain consistent growth, leading to concerns about its ability to meet future debt obligations. Investors should approach Pilgrim’s Pride with caution, carefully analyzing its financials and other relevant factors before making any investment decisions.
Conclusion and investor advice
Consequently, shareholders are advised to be vigilant regarding Pilgrim’s Pride and closely monitor its liquidity while assessing debt levels. While it is essential to acknowledge that the company may have valid reasons for accumulating debt, consistently increasing debt without substantial growth can be cause for concern. Investors should analyze the company’s overall financial health, profitability, and growth potential before making any long-term decisions, ensuring they fully understand the risks and rewards associated with Pilgrim’s Pride’s debt situation.
First Reported on: simplywall.st
FAQs
1. What factors should investors consider when evaluating Pilgrim’s Pride’s debt levels?
Investors should examine the company’s debt-to-equity ratio, liquidity, and overall financial health to determine the risks associated with Pilgrim’s Pride’s debt levels and make well-informed decisions about whether the rewards outweigh the risks.
2. How do debt and cash management play a role in a company’s financial health?
Proper debt management allows businesses to expand and improve their creditworthiness, facilitating better terms for future borrowing. Analyzing a company’s debt usage and cash holdings together can provide a clear understanding of the company’s overall financial health and its ability to meet its obligations.
3. What are some of the key ratios used to gauge debt relative to earnings?
Two primary ratios used to determine debt levels relative to earnings are net debt divided by earnings before interest, tax, depreciation, and amortization (EBITDA) and the number of times earnings before interest and tax (EBIT) covers interest expenses (interest cover).
4. Why is it important to consider EBIT and free cash flow when analyzing a company’s ability to repay debt?
Examining the proportion of EBIT matched by real free cash flow is essential, as accounting profits might suffice for tax purposes, but lenders require actual cash. This helps investors understand the company’s ability to repay debt based on its available cash sources and not just accounting profits.
5. How is Pilgrim’s Pride perceived in terms of financial risk?
Due to its disappointing EBIT growth rate and its net debt to EBITDA ratio that does not inspire confidence, Pilgrim’s Pride is perceived as a high-risk company in terms of balance sheet health. This perception is further reinforced by the company’s recent struggles to maintain consistent growth, leading to concerns about its ability to meet future debt obligations.
6. What advice can be given to investors regarding Pilgrim’s Pride?
Shareholders are advised to be vigilant and closely monitor Pilgrim’s Pride’s liquidity and debt levels. Investors should analyze the company’s overall financial health, profitability, and growth potential before making any long-term decisions, ensuring they fully understand the risks and rewards associated with Pilgrim’s Pride’s debt situation.
