These 4 Measures Indicate That Swiss Water Decaffeinated Coffee (TSE:SWP) Is Using Debt In A Risky Way

Warren Buffett famously said, 'Volatility is far from synonymous with risk.' So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. We note that Swiss Water Decaffeinated Coffee Inc. (TSE:SWP) does have debt on its balance sheet. But the more important question is: how much risk is that debt creating?

What Risk Does Debt Bring?

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. 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. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. The first step when considering a company's debt levels is to consider its cash and debt together.

Check out our latest analysis for Swiss Water Decaffeinated Coffee

What Is Swiss Water Decaffeinated Coffee's Debt?

The image below, which you can click on for greater detail, shows that at September 2021 Swiss Water Decaffeinated Coffee had debt of CA$54.5m, up from CA$44.6m in one year. However, it also had CA$2.13m in cash, and so its net debt is CA$52.4m.

How Strong Is Swiss Water Decaffeinated Coffee's Balance Sheet?

We can see from the most recent balance sheet that Swiss Water Decaffeinated Coffee had liabilities of CA$20.8m falling due within a year, and liabilities of CA$81.3m due beyond that. Offsetting these obligations, it had cash of CA$2.13m as well as receivables valued at CA$19.0m due within 12 months. So its liabilities total CA$81.0m more than the combination of its cash and short-term receivables.

This deficit casts a shadow over the CA$32.0m 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.

In order to size up a company's debt relative to its earnings, we calculate its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and its earnings before interest and tax (EBIT) divided by its interest expense (its interest cover). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

Swiss Water Decaffeinated Coffee shareholders face the double whammy of a high net debt to EBITDA ratio (5.4), and fairly weak interest coverage, since EBIT is just 1.4 times the interest expense. This means we'd consider it to have a heavy debt load. Even more troubling is the fact that Swiss Water Decaffeinated Coffee actually let its EBIT decrease by 4.6% over the last year. If that earnings trend continues the company will face an uphill battle to pay off its debt. The balance sheet is clearly the area to focus on when you are analysing debt. But it is Swiss Water Decaffeinated Coffee'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.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. So it's worth checking how much of that EBIT is backed by 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

To be frank both Swiss Water Decaffeinated Coffee's conversion of EBIT to free cash flow and its track record of staying on top of its total liabilities make us rather uncomfortable with its debt levels. And even its net debt to EBITDA fails to inspire much confidence. Considering all the factors previously mentioned, we think that Swiss Water Decaffeinated Coffee really is carrying too much debt. To us, that makes the stock rather risky, like walking through a dog park with your eyes closed. But some investors may feel differently. 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. Be aware that Swiss Water Decaffeinated Coffee is showing 3 warning signs in our investment analysis , and 2 of those are a bit unpleasant...

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.

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.

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