PBG (BVMF:PTBL3) Seems To Use Debt Quite Sensibly

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. Importantly, PBG S.A. (BVMF:PTBL3) does carry debt. But the real question is whether this debt is making the company risky.

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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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, plenty of companies use debt to fund growth, without any negative consequences. When we think about a company's use of debt, we first look at cash and debt together.

See our latest analysis for PBG

What Is PBG's Net Debt?

As you can see below, PBG had R$710.3m of debt at March 2021, down from R$795.5m a year prior. However, because it has a cash reserve of R$242.9m, its net debt is less, at about R$467.4m.

How Healthy Is PBG's Balance Sheet?

According to the last reported balance sheet, PBG had liabilities of R$760.3m due within 12 months, and liabilities of R$838.0m due beyond 12 months. Offsetting these obligations, it had cash of R$242.9m as well as receivables valued at R$392.3m due within 12 months. So its liabilities total R$963.1m more than the combination of its cash and short-term receivables.

While this might seem like a lot, it is not so bad since PBG has a market capitalization of R$2.57b, and so it could probably strengthen its balance sheet by raising capital if it needed to. 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). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

PBG has a debt to EBITDA ratio of 2.6 and its EBIT covered its interest expense 4.0 times. This suggests that while the debt levels are significant, we'd stop short of calling them problematic. Importantly, PBG grew its EBIT by 77% over the last twelve months, and that growth will make it easier to handle its debt. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since PBG will need earnings to service that debt. 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. During the last three years, PBG produced sturdy free cash flow equating to 67% 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

The good news is that PBG's demonstrated ability to grow its EBIT delights us like a fluffy puppy does a toddler. But truth be told we feel its interest cover does undermine this impression a bit. Looking at all the aforementioned factors together, it strikes us that PBG can handle its debt fairly comfortably. On the plus side, this leverage can boost shareholder returns, but the potential downside is more risk of loss, so it's worth monitoring the balance sheet. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. We've identified 3 warning signs with PBG , and understanding them should be part of your investment process.

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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