Here's Why Nestlé (VTX:NESN) Can Manage Its Debt Responsibly

Warren Buffett famously said, 'Volatility is far from synonymous with risk.' 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. Importantly, Nestlé S.A. (VTX:NESN) does carry debt. But the more important question is: how much risk is that debt creating?

Our free stock report includes 1 warning sign investors should be aware of before investing in Nestlé. Read for free now.

When Is Debt A Problem?

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 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 think about a company's use of debt, we first look at cash and debt together.

What Is Nestlé's Debt?

As you can see below, at the end of December 2024, Nestlé had CHF60.6b of debt, up from CHF52.3b a year ago. Click the image for more detail. However, because it has a cash reserve of CHF7.87b, its net debt is less, at about CHF52.7b.

How Strong Is Nestlé's Balance Sheet?

The latest balance sheet data shows that Nestlé had liabilities of CHF42.9b due within a year, and liabilities of CHF59.7b falling due after that. On the other hand, it had cash of CHF7.87b and CHF12.6b worth of receivables due within a year. So it has liabilities totalling CHF82.1b more than its cash and near-term receivables, combined.

While this might seem like a lot, it is not so bad since Nestlé has a huge market capitalization of CHF224.0b, and so it could probably strengthen its balance sheet by raising capital if it needed to. However, it is still worthwhile taking a close look at its ability to pay off debt.

Check out our latest analysis for Nestlé

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). 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).

Nestlé has a debt to EBITDA ratio of 2.9, which signals significant debt, but is still pretty reasonable for most types of business. However, its interest coverage of 10.9 is very high, suggesting that the interest expense on the debt is currently quite low. Importantly Nestlé's EBIT was essentially flat over the last twelve months. We would prefer to see some earnings growth, because that always helps diminish debt. There's no doubt that we learn most about debt from the balance sheet. But ultimately the future profitability of the business will decide if Nestlé 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 we always check how much of that EBIT is translated into free cash flow. During the last three years, Nestlé produced sturdy free cash flow equating to 58% of its EBIT, about what we'd expect. This cold hard cash means it can reduce its debt when it wants to.

Our View

On our analysis Nestlé's interest cover should signal that it won't have too much trouble with its debt. But the other factors we noted above weren't so encouraging. For instance it seems like it has to struggle a bit handle its debt, based on its EBITDA,. Considering this range of data points, we think Nestlé is in a good position to manage its debt levels. But a word of caution: we think debt levels are high enough to justify ongoing monitoring. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. To that end, you should be aware of the 1 warning sign we've spotted with Nestlé .

When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.

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

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.