We Think Emmi (VTX:EMMN) Can Stay On Top Of Its Debt

Legendary fund manager Li Lu (who Charlie Munger backed) once said, '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, Emmi AG (VTX:EMMN) does carry debt. But the more important question is: how much risk is that debt creating?

Why Does Debt Bring Risk?

Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. Of course, plenty of companies use debt to fund growth, without any negative consequences. When we examine debt levels, we first consider both cash and debt levels, together.

See our latest analysis for Emmi

What Is Emmi's Debt?

You can click the graphic below for the historical numbers, but it shows that as of December 2022 Emmi had CHF692.8m of debt, an increase on CHF657.5m, over one year. On the flip side, it has CHF204.1m in cash leading to net debt of about CHF488.7m.

How Healthy Is Emmi's Balance Sheet?

According to the last reported balance sheet, Emmi had liabilities of CHF821.1m due within 12 months, and liabilities of CHF530.4m due beyond 12 months. On the other hand, it had cash of CHF204.1m and CHF592.2m worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by CHF555.2m.

Since publicly traded Emmi shares are worth a total of CHF5.05b, it seems unlikely that this level of liabilities would be a major threat. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time.

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). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

Emmi has a low net debt to EBITDA ratio of only 1.3. And its EBIT easily covers its interest expense, being 19.0 times the size. So you could argue it is no more threatened by its debt than an elephant is by a mouse. But the other side of the story is that Emmi saw its EBIT decline by 5.5% over the last year. That sort of decline, if sustained, will obviously make debt harder to handle. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately the future profitability of the business will decide if Emmi 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.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. So it's worth checking how much of that EBIT is backed by free cash flow. Looking at the most recent three years, Emmi recorded free cash flow of 39% of its EBIT, which is weaker than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.

Our View

When it comes to the balance sheet, the standout positive for Emmi was the fact that it seems able to cover its interest expense with its EBIT confidently. However, our other observations weren't so heartening. For instance it seems like it has to struggle a bit to grow its EBIT. When we consider all the elements mentioned above, it seems to us that Emmi is managing its debt quite well. Having said that, the load is sufficiently heavy that we would recommend any shareholders keep a close eye on it. Above most other metrics, we think its important to track how fast earnings per share is growing, if at all. If you've also come to that realization, you're in luck, because today you can view this interactive graph of Emmi's earnings per share history for free.

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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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.