Warren Buffett famously said, ‘Volatility is far from synonymous with risk.’ So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. We note that Coca-Cola HBC AG (LON:CCH) does have debt on its balance sheet. But the more important question is: how much risk is that debt creating?
Why Does Debt Bring Risk?
Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. If things get really bad, the lenders can take control of the business. 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. Of course, plenty of companies use debt to fund growth, without any negative consequences. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.
See our latest analysis for Coca-Cola HBC
What Is Coca-Cola HBC’s Debt?
As you can see below, Coca-Cola HBC had €2.74b of debt at December 2020, down from €3.11b a year prior. However, because it has a cash reserve of €1.31b, its net debt is less, at about €1.43b.
How Strong Is Coca-Cola HBC’s Balance Sheet?
We can see from the most recent balance sheet that Coca-Cola HBC had liabilities of €2.03b falling due within a year, and liabilities of €2.91b due beyond that. Offsetting this, it had €1.31b in cash and €725.9m in receivables that were due within 12 months. So its liabilities total €2.91b more than the combination of its cash and short-term receivables.
This deficit isn’t so bad because Coca-Cola HBC is worth a massive €11.1b, and thus could probably raise enough capital to shore up its balance sheet, if the need arose. But we definitely want to keep our eyes open to indications that its debt is bringing too much risk.
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.
Coca-Cola HBC has net debt of just 1.5 times EBITDA, indicating that it is certainly not a reckless borrower. And it boasts interest cover of 9.5 times, which is more than adequate. On the other hand, Coca-Cola HBC’s EBIT dived 14%, over the last year. If that rate of decline in earnings continues, the company could find itself in a tight spot. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately the future profitability of the business will decide if Coca-Cola HBC 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, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. During the last three years, Coca-Cola HBC produced sturdy free cash flow equating to 65% of its EBIT, about what we’d expect. This free cash flow puts the company in a good position to pay down debt, when appropriate.
Based on what we’ve seen Coca-Cola HBC is not finding it easy, given its EBIT growth rate, but the other factors we considered give us cause to be optimistic. There’s no doubt that its ability to to cover its interest expense with its EBIT is pretty flash. When we consider all the factors mentioned above, we do feel a bit cautious about Coca-Cola HBC’s use of debt. While we appreciate debt can enhance returns on equity, we’d suggest that shareholders keep close watch on its debt levels, lest they increase. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. Case in point: We’ve spotted 2 warning signs for Coca-Cola HBC you should be aware of.
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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