We Think Givaudan (VTX:GIVN) Can Stay On Top Of Its Debt

Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' 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 can see that Givaudan SA (VTX:GIVN) does use debt in its business. But the more important question is: how much risk is that debt creating?

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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, plenty of companies use debt to fund growth, without any negative consequences. The first step when considering a company's debt levels is to consider its cash and debt together.

View our latest analysis for Givaudan

What Is Givaudan's Net Debt?

The chart below, which you can click on for greater detail, shows that Givaudan had CHF4.91b in debt in June 2024; about the same as the year before. However, because it has a cash reserve of CHF659.0m, its net debt is less, at about CHF4.25b.

A Look At Givaudan's Liabilities

According to the last reported balance sheet, Givaudan had liabilities of CHF2.97b due within 12 months, and liabilities of CHF4.90b due beyond 12 months. Offsetting this, it had CHF659.0m in cash and CHF2.01b in receivables that were due within 12 months. So its liabilities total CHF5.20b more than the combination of its cash and short-term receivables.

Given Givaudan has a humongous market capitalization of CHF38.7b, it's hard to believe these liabilities pose much threat. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time.

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 2.8, which signals significant debt, but is still pretty reasonable for most types of business. However, its interest coverage of 14.0 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 19% 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 ultimately the future profitability of the business will decide if Givaudan 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, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. Over the last three years, Givaudan recorded free cash flow worth a fulsome 81% 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. Looking at the bigger picture, we think Givaudan's use of debt seems quite reasonable and we're not concerned about it. While debt does bring risk, when used wisely it can also bring a higher return 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. Case in point: We've spotted 1 warning sign for Givaudan you should be aware of.

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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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.