The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' 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. 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.
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. 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.
What Is Compañía Cervecerías Unidas's Net Debt?
You can click the graphic below for the historical numbers, but it shows that as of March 2021 Compañía Cervecerías Unidas had CL$472.2b of debt, an increase on CL$304.1b, over one year. But it also has CL$480.5b in cash to offset that, meaning it has CL$8.34b net cash.
How Healthy Is Compañía Cervecerías Unidas' Balance Sheet?
According to the last reported balance sheet, Compañía Cervecerías Unidas had liabilities of CL$554.8b due within 12 months, and liabilities of CL$598.0b due beyond 12 months. Offsetting this, it had CL$480.5b in cash and CL$246.8b in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by CL$425.4b.
Of course, Compañía Cervecerías Unidas has a market capitalization of CL$2.41t, so these liabilities are probably manageable. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time. Despite its noteworthy liabilities, Compañía Cervecerías Unidas boasts net cash, so it's fair to say it does not have a heavy debt load!
But the other side of the story is that Compañía Cervecerías Unidas saw its EBIT decline by 6.6% over the last year. That sort of decline, if sustained, will obviously make debt harder to handle. There's no doubt that we learn most about debt from the balance sheet. But it is future earnings, more than anything, that will determine Compañía Cervecerías Unidas'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.
Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. Compañía Cervecerías Unidas may have net cash on the balance sheet, but it is still interesting to look at how well the business converts its earnings before interest and tax (EBIT) to free cash flow, because that will influence both its need for, and its capacity to manage debt. Over the last three years, Compañía Cervecerías Unidas recorded free cash flow worth a fulsome 85% of its EBIT, which is stronger than we'd usually expect. That positions it well to pay down debt if desirable to do so.
While Compañía Cervecerías Unidas does have more liabilities than liquid assets, it also has net cash of CL$8.34b. And it impressed us with free cash flow of CL$205b, being 85% of its EBIT. So we don't have any problem with Compañía Cervecerías Unidas's use of debt. 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. We've identified 1 warning sign with Compañía Cervecerías Unidas , and understanding them should be part of your investment process.
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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