Heineken Holding (AMS:HEIO) Takes On Some Risk With Its Use Of Debt

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.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. We can see that Heineken Holding N.V. (AMS:HEIO) does use debt in its business. But the real question is whether this debt is making the company risky.

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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, debt can be an important tool in businesses, particularly capital heavy businesses. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

View our latest analysis for Heineken Holding

What Is Heineken Holding's Debt?

The image below, which you can click on for greater detail, shows that at December 2023 Heineken Holding had debt of €17.0b, up from €15.1b in one year. However, it does have €2.38b in cash offsetting this, leading to net debt of about €14.6b.

How Healthy Is Heineken Holding's Balance Sheet?

According to the last reported balance sheet, Heineken Holding had liabilities of €14.8b due within 12 months, and liabilities of €17.5b due beyond 12 months. On the other hand, it had cash of €2.38b and €4.68b worth of receivables due within a year. So its liabilities total €25.3b more than the combination of its cash and short-term receivables.

Given this deficit is actually higher than the company's massive market capitalization of €20.3b, we think shareholders really should watch Heineken Holding's debt levels, like a parent watching their child ride a bike for the first time. Hypothetically, extremely heavy dilution would be required if the company were forced to pay down its liabilities by raising capital at the current share price.

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.

With net debt to EBITDA of 2.6 Heineken Holding has a fairly noticeable amount of debt. But the high interest coverage of 7.4 suggests it can easily service that debt. Importantly Heineken Holding's EBIT was essentially flat over the last twelve months. We would prefer to see some earnings growth, because that always helps diminish debt. There's no doubt that we learn most about debt from the balance sheet. But it is Heineken Holding's earnings that will influence how the balance sheet holds up in the future. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So it's worth checking how much of that EBIT is backed by free cash flow. Over the most recent three years, Heineken Holding recorded free cash flow worth 60% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This free cash flow puts the company in a good position to pay down debt, when appropriate.

Our View

Heineken Holding's struggle to handle its total liabilities had us second guessing its balance sheet strength, but the other data-points we considered were relatively redeeming. For example, its conversion of EBIT to free cash flow is relatively strong. When we consider all the factors discussed, it seems to us that Heineken Holding is taking some risks with its use of debt. While that debt can boost returns, we think the company has enough leverage now. 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. Be aware that Heineken Holding is showing 3 warning signs in our investment analysis , you should know about...

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

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This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.