Swiss Water Decaffeinated Coffee (TSE:SWP) Use Of Debt Could Be Considered Risky

The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' So it seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. Importantly, Swiss Water Decaffeinated Coffee Inc. (TSE:SWP) does carry debt. But the real question is whether this debt is making the company risky.

Why Does Debt Bring Risk?

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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we examine debt levels, we first consider both cash and debt levels, together.

Check out our latest analysis for Swiss Water Decaffeinated Coffee

What Is Swiss Water Decaffeinated Coffee's Debt?

You can click the graphic below for the historical numbers, but it shows that as of March 2021 Swiss Water Decaffeinated Coffee had CA$45.4m of debt, an increase on CA$41.2m, over one year. However, it does have CA$2.12m in cash offsetting this, leading to net debt of about CA$43.3m.

A Look At Swiss Water Decaffeinated Coffee's Liabilities

The latest balance sheet data shows that Swiss Water Decaffeinated Coffee had liabilities of CA$15.9m due within a year, and liabilities of CA$71.8m falling due after that. Offsetting these obligations, it had cash of CA$2.12m as well as receivables valued at CA$16.3m due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by CA$69.2m.

This deficit casts a shadow over the CA$27.8m company, like a colossus towering over mere mortals. So we'd watch its balance sheet closely, without a doubt. After all, Swiss Water Decaffeinated Coffee would likely require a major re-capitalisation if it had to pay its creditors today.

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). The advantage of this approach is that we take into account both the absolute quantum of debt (with net debt to EBITDA) and the actual interest expenses associated with that debt (with its interest cover ratio).

Weak interest cover of 1.3 times and a disturbingly high net debt to EBITDA ratio of 6.2 hit our confidence in Swiss Water Decaffeinated Coffee like a one-two punch to the gut. The debt burden here is substantial. Worse, Swiss Water Decaffeinated Coffee's EBIT was down 38% over the last year. If earnings keep going like that over the long term, it has a snowball's chance in hell of paying off that debt. There's no doubt that we learn most about debt from the balance sheet. 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 company can only pay off debt with cold hard cash, not accounting profits. So the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. Over the last three years, Swiss Water Decaffeinated Coffee saw substantial negative free cash flow, in total. 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 EBIT growth rate 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 furthermore, its interest cover also fails to instill confidence. Considering everything we've mentioned above, it's fair to say that Swiss Water Decaffeinated Coffee is carrying heavy debt load. If you harvest honey without a bee suit, you risk getting stung, so we'd probably stay away from this particular stock. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. For example, we've discovered 4 warning signs for Swiss Water Decaffeinated Coffee (1 is concerning!) that you should be aware of before investing here.

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’re looking to trade a wide range of investments, open an account with the lowest-cost* platform trusted by professionals, Interactive Brokers. Their clients from over 200 countries and territories trade stocks, options, futures, forex, bonds and funds worldwide 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.