Is Givaudan (VTX:GIVN) A Risky Investment?

David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the permanent loss of capital.' 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 Givaudan SA (VTX:GIVN) does have debt on its balance sheet. But should shareholders be worried about its use of debt?

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. If things get really bad, the lenders can take control of the business. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

View our latest analysis for Givaudan

What Is Givaudan's Debt?

The image below, which you can click on for greater detail, shows that at June 2020 Givaudan had debt of CHF4.64b, up from CHF3.54b in one year. On the flip side, it has CHF436.0m in cash leading to net debt of about CHF4.21b.

How Healthy Is Givaudan's Balance Sheet?

The latest balance sheet data shows that Givaudan had liabilities of CHF2.38b due within a year, and liabilities of CHF5.37b falling due after that. On the other hand, it had cash of CHF436.0m and CHF1.66b worth of receivables due within a year. So it has liabilities totalling CHF5.66b more than its cash and near-term receivables, combined.

Of course, Givaudan has a titanic market capitalization of CHF32.7b, so these liabilities are probably manageable. 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). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

Givaudan has a debt to EBITDA ratio of 3.3, which signals significant debt, but is still pretty reasonable for most types of business. However, its interest coverage of 14.4 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 14% 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 want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So it's worth checking how much of that EBIT is backed by free cash flow. During the last three years, Givaudan produced sturdy free cash flow equating to 79% of its EBIT, about what we'd expect. This free cash flow puts the company in a good position to pay down debt, when appropriate.

Our View

Happily, Givaudan's impressive interest cover implies it has the upper hand on its debt. But, on a more sombre note, we are a little concerned by its net debt to EBITDA. 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. However, not all investment risk resides within the balance sheet - far from it. To that end, you should be aware of the 1 warning sign we've spotted with Givaudan .

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.

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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.
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