Is Swiss Water Decaffeinated Coffee (TSE:SWP) A Risky Investment?

Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' 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. As with many other companies Swiss Water Decaffeinated Coffee Inc. (TSE:SWP) makes use of debt. But is this debt a concern to shareholders?

When Is Debt Dangerous?

Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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. When we think about a company's use of debt, we first look at cash and debt together.

View our latest analysis for Swiss Water Decaffeinated Coffee

How Much Debt Does Swiss Water Decaffeinated Coffee Carry?

As you can see below, at the end of September 2020, Swiss Water Decaffeinated Coffee had CA$44.6m of debt, up from CA$30.5m a year ago. Click the image for more detail. However, because it has a cash reserve of CA$2.18m, its net debt is less, at about CA$42.4m.

A Look At Swiss Water Decaffeinated Coffee's Liabilities

Zooming in on the latest balance sheet data, we can see that Swiss Water Decaffeinated Coffee had liabilities of CA$13.4m due within 12 months and liabilities of CA$73.0m due beyond that. Offsetting these obligations, it had cash of CA$2.18m as well as receivables valued at CA$16.8m due within 12 months. So it has liabilities totalling CA$67.5m more than its cash and near-term receivables, combined.

The deficiency here weighs heavily on the CA$29.6m company itself, as if a child were struggling under the weight of an enormous back-pack full of books, his sports gear, and a trumpet. So we'd watch its balance sheet closely, without a doubt. At the end of the day, Swiss Water Decaffeinated Coffee would probably need a major re-capitalization if its creditors were to demand repayment.

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 a net debt to EBITDA ratio of 6.3, it's fair to say Swiss Water Decaffeinated Coffee does have a significant amount of debt. However, its interest coverage of 3.9 is reasonably strong, which is a good sign. Investors should also be troubled by the fact that Swiss Water Decaffeinated Coffee saw its EBIT drop by 11% over the last twelve months. If things keep going like that, handling the debt will about as easy as bundling an angry house cat into its travel box. The balance sheet is clearly the area to focus on when you are analysing debt. But you can't view debt in total isolation; since Swiss Water Decaffeinated Coffee will need earnings to service that debt. So if you're keen to discover more about its earnings, it might be worth checking out this graph of its long term earnings trend.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. 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, Swiss Water Decaffeinated Coffee burned a lot of cash. While that may be a result of expenditure for growth, it does make the debt far more risky.

Our View

On the face of it, Swiss Water Decaffeinated Coffee's conversion of EBIT to free cash flow left us tentative about the stock, and its level of total liabilities was no more enticing than the one empty restaurant on the busiest night of the year. And even its EBIT growth rate fails to inspire much confidence. We think the chances that Swiss Water Decaffeinated Coffee has too much debt a very significant. To our minds, that means the stock is rather high risk, and probably one to avoid; but to each their own (investing) style. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. Be aware that Swiss Water Decaffeinated Coffee is showing 3 warning signs in our investment analysis , and 2 of those make us uncomfortable...

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.

If you decide to trade Swiss Water Decaffeinated Coffee, use the lowest-cost* platform that is rated #1 Overall by Barron’s, Interactive Brokers. Trade stocks, options, futures, forex, bonds and funds on 135 markets, all from a single integrated account. Promoted

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.
^*Interactive Brokers Rated Lowest Cost Broker by StockBrokers.com Annual Online Review 2020

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.