David Iben put it well when he said, ‘Volatility is not a risk we care about. What we care about is avoiding the permanent loss of capital. 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 can see that Compañía Cervecerías Unidas S.A. (SNSE:CCU) does use debt in its business. But the real question is whether this debt is making the company risky.
When Is Debt A Problem?
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. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. 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. The first step when considering a company’s debt levels is to consider its cash and debt together.
Check out our latest analysis for Compañía Cervecerías Unidas
What Is Compañía Cervecerías Unidas’s Debt?
You can click the graphic below for the historical numbers, but it shows that as of March 2020 Compañía Cervecerías Unidas had CL$304.1b of debt, an increase on CL$255.5b, over one year. However, it also had CL$228.9b in cash, and so its net debt is CL$75.1b.
How Strong Is Compañía Cervecerías Unidas’s Balance Sheet?
The latest balance sheet data shows that Compañía Cervecerías Unidas had liabilities of CL$502.2b due within a year, and liabilities of CL$434.4b falling due after that. Offsetting these obligations, it had cash of CL$228.9b as well as receivables valued at CL$280.1b due within 12 months. So its liabilities total CL$427.5b more than the combination of its cash and short-term receivables.
Compañía Cervecerías Unidas has a market capitalization of CL$2.03t, so it could very likely raise cash to ameliorate 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.
We measure a company’s debt load relative to its earnings power by looking at its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and by calculating how easily its earnings before interest and tax (EBIT) cover its interest expense (interest cover). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.
Compañía Cervecerías Unidas’s net debt is only 0.23 times its EBITDA. And its EBIT easily covers its interest expense, being 11.5 times the size. So we’re pretty relaxed about its super-conservative use of debt. On the other hand, Compañía Cervecerías Unidas saw its EBIT drop by 7.8% in the last twelve months. If earnings continue to decline at that rate the company may have increasing difficulty managing its debt load. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Compañía Cervecerías Unidas 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.
But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So we always check how much of that EBIT is translated into free cash flow. During the last three years, Compañía Cervecerías Unidas produced sturdy free cash flow equating to 75% 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.
Our View
Compañía Cervecerías Unidas’s interest cover suggests it can handle its debt as easily as Cristiano Ronaldo could score a goal against an under 14’s goalkeeper. But truth be told we feel its EBIT growth rate does undermine this impression a bit. Taking all this data into account, it seems to us that Compañía Cervecerías Unidas takes a pretty sensible approach to debt. While that brings some risk, it can also enhance returns for shareholders. 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. Consider for instance, the ever-present spectre of investment risk. We’ve identified 3 warning signs with Compañía Cervecerías Unidas , and understanding them should be part of your investment process.
If you’re interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.
Love or hate this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team@simplywallst.com.
This article by Simply Wall St is general in nature. 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. Thank you for reading.