We Think Compañía Cervecerías Unidas (SNSE:CCU) Is Taking Some Risk With Its Debt

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.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. We can see that Compañía Cervecerías Unidas S.A. (SNSE:CCU) does use debt in its business. But the real question is whether this debt is making the company risky.

Why Does Debt Bring Risk?

Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we think about a company's use of debt, we first look at cash and debt together.

Check out our latest analysis for Compañía Cervecerías Unidas

What Is Compañía Cervecerías Unidas's Net Debt?

As you can see below, Compañía Cervecerías Unidas had CL$1.35t of debt, at September 2024, which is about the same as the year before. You can click the chart for greater detail. However, it also had CL$600.1b in cash, and so its net debt is CL$749.9b.

How Strong Is Compañía Cervecerías Unidas' Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Compañía Cervecerías Unidas had liabilities of CL$759.5b due within 12 months and liabilities of CL$1.38t due beyond that. Offsetting these obligations, it had cash of CL$600.1b as well as receivables valued at CL$435.7b due within 12 months. So its liabilities total CL$1.10t 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$2.17t, and so it could probably strengthen its balance sheet by raising capital if it needed to. But it's clear that we should definitely closely examine whether it can manage its debt without dilution.

We measure a company's debt load relative to its earnings power by looking at its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and by calculating how easily its earnings before interest and tax (EBIT) cover its interest expense (interest cover). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

Compañía Cervecerías Unidas has a debt to EBITDA ratio of 2.8 and its EBIT covered its interest expense 3.3 times. Taken together this implies that, while we wouldn't want to see debt levels rise, we think it can handle its current leverage. Even worse, Compañía Cervecerías Unidas saw its EBIT tank 32% over the last 12 months. If earnings continue to follow that trajectory, paying off that debt load will be harder than convincing us to run a marathon in the rain. 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, 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. In the last three years, Compañía Cervecerías Unidas created free cash flow amounting to 7.2% of its EBIT, an uninspiring performance. That limp level of cash conversion undermines its ability to manage and pay down debt.

Our View

Mulling over Compañía Cervecerías Unidas's attempt at (not) growing its EBIT, we're certainly not enthusiastic. But at least its level of total liabilities is not so bad. We're quite clear that we consider Compañía Cervecerías Unidas to be really rather risky, as a result of its balance sheet health. So we're almost as wary of this stock as a hungry kitten is about falling into its owner's fish pond: once bitten, twice shy, as they say. 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. For instance, we've identified 2 warning signs for Compañía Cervecerías Unidas (1 shouldn't be ignored) you should be aware of.

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.