Here's Why Compañía Cervecerías Unidas (SNSE:CCU) Can Manage Its Debt Responsibly

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 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 Compañía Cervecerías Unidas S.A. (SNSE:CCU) does have debt on its balance sheet. But the real question is whether this debt is making the company risky.

Why Does Debt Bring Risk?

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. 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. 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. When we examine debt levels, we first consider both cash and debt levels, together.

Check out our latest analysis for Compañía Cervecerías Unidas

What Is Compañía Cervecerías Unidas's Debt?

You can click the graphic below for the historical numbers, but it shows that as of March 2022 Compañía Cervecerías Unidas had CL$1.02t of debt, an increase on CL$472.2b, over one year. However, it does have CL$756.0b in cash offsetting this, leading to net debt of about CL$268.6b.

How Strong Is Compañía Cervecerías Unidas' Balance Sheet?

According to the last reported balance sheet, Compañía Cervecerías Unidas had liabilities of CL$819.5b due within 12 months, and liabilities of CL$1.11t due beyond 12 months. Offsetting this, it had CL$756.0b in cash and CL$358.3b in receivables that were due within 12 months. So its liabilities total CL$815.5b more than the combination of its cash and short-term receivables.

While this might seem like a lot, it is not so bad since Compañía Cervecerías Unidas has a market capitalization of CL$2.14t, 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.

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).

Compañía Cervecerías Unidas's net debt is only 0.61 times its EBITDA. And its EBIT covers its interest expense a whopping 13.7 times over. So we're pretty relaxed about its super-conservative use of debt. On top of that, Compañía Cervecerías Unidas grew its EBIT by 59% over the last twelve months, and that growth will make it easier to handle its debt. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Compañía Cervecerías Unidas 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. Looking at the most recent three years, Compañía Cervecerías Unidas recorded free cash flow of 43% of its EBIT, which is weaker than we'd expect. That's not great, when it comes to paying down debt.

Our View

The good news is that Compañía Cervecerías Unidas's demonstrated ability to cover its interest expense with its EBIT delights us like a fluffy puppy does a toddler. And the good news does not stop there, as its EBIT growth rate also supports that impression! When we consider the range of factors above, it looks like Compañía Cervecerías Unidas is pretty sensible with its use of debt. That means they are taking on a bit more risk, in the hope of boosting shareholder returns. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. Be aware that Compañía Cervecerías Unidas is showing 2 warning signs in our investment analysis , you should know about...

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.