Conagra Brands (NYSE:CAG) Takes On Some Risk With Its Use Of Debt (2024)

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.' 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. We note that Conagra Brands, Inc. (NYSE:CAG) does have debt on its balance sheet. 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. If things get really bad, the lenders can take control of the business. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. Of course, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. When we examine debt levels, we first consider both cash and debt levels, together.

View our latest analysis for Conagra Brands

What Is Conagra Brands's Debt?

The chart below, which you can click on for greater detail, shows that Conagra Brands had US$9.07b in debt in November 2023; about the same as the year before. And it doesn't have much cash, so its net debt is about the same.

How Strong Is Conagra Brands' Balance Sheet?

We can see from the most recent balance sheet that Conagra Brands had liabilities of US$3.83b falling due within a year, and liabilities of US$9.21b due beyond that. On the other hand, it had cash of US$61.5m and US$974.1m worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by US$12.0b.

This deficit is considerable relative to its very significant market capitalization of US$13.1b, so it does suggest shareholders should keep an eye on Conagra Brands' use of debt. Should its lenders demand that it shore up the balance sheet, shareholders would likely face severe 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). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

Conagra Brands has a debt to EBITDA ratio of 4.0 and its EBIT covered its interest expense 4.4 times. Taken together this implies that, while we wouldn't want to see debt levels rise, we think it can handle its current leverage. Fortunately, Conagra Brands grew its EBIT by 3.6% in the last year, slowly shrinking its debt relative to earnings. 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 Conagra Brands 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, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So we always check how much of that EBIT is translated into free cash flow. In the last three years, Conagra Brands's free cash flow amounted to 49% of its EBIT, less than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.

Our View

On this analysis Conagra Brands's net debt to EBITDA and level of total liabilities both make us a little nervous. But at least its conversion of EBIT to free cash flow is not so bad. Looking at the balance sheet and taking into account all these factors, we do believe that debt is making Conagra Brands stock a bit risky. Some people like that sort of risk, but we're mindful of the potential pitfalls, so we'd probably prefer it carry less debt. 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. To that end, you should learn about the 3 warning signs we've spotted with Conagra Brands (including 1 which is a bit concerning) .

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.