Givaudan (VTX:GIVN) Has A Pretty Healthy Balance Sheet

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. We note that Givaudan SA (VTX:GIVN) does have debt on its balance sheet. But the more important question is: how much risk is that debt creating?

When Is Debt A Problem?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. Of course, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. The first step when considering a company's debt levels is to consider its cash and debt together.

See our latest analysis for Givaudan

What Is Givaudan's Debt?

You can click the graphic below for the historical numbers, but it shows that as of December 2020 Givaudan had CHF4.04b of debt, an increase on CHF3.69b, over one year. On the flip side, it has CHF415.0m in cash leading to net debt of about CHF3.62b.

A Look At Givaudan's Liabilities

According to the last reported balance sheet, Givaudan had liabilities of CHF1.80b due within 12 months, and liabilities of CHF5.35b due beyond 12 months. Offsetting this, it had CHF415.0m in cash and CHF1.58b in receivables that were due within 12 months. So it has liabilities totalling CHF5.16b more than its cash and near-term receivables, combined.

Since publicly traded Givaudan shares are worth a very impressive total of CHF32.4b, it seems unlikely that this level of liabilities would be a major threat. But there are sufficient liabilities that we would certainly recommend shareholders continue to monitor the balance sheet, going forward.

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).

Givaudan's net debt is 2.7 times its EBITDA, which is a significant but still reasonable amount of leverage. However, its interest coverage of 13.4 is very high, suggesting that the interest expense on the debt is currently quite low. If Givaudan can keep growing EBIT at last year's rate of 11% over the last year, then it will find its debt load easier to manage. The balance sheet is clearly the area to focus on when you are analysing debt. But it is future earnings, more than anything, that will determine Givaudan's ability to maintain a healthy balance sheet going forward. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

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. Over the last three years, Givaudan recorded free cash flow worth a fulsome 83% of its EBIT, which is stronger than we'd usually expect. That positions it well to pay down debt if desirable to do so.

Our View

Happily, Givaudan's impressive interest cover implies it has the upper hand on its debt. But truth be told we feel its net debt to EBITDA does undermine this impression a bit. Zooming out, Givaudan seems to use debt quite reasonably; and that gets the nod from us. After all, sensible leverage can boost returns on equity. 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. We've identified 1 warning sign with Givaudan , and understanding them should be part of your investment process.

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

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