We Think Carlsberg (CPH:CARL B) Can Stay On Top Of Its Debt

Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk.' 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. As with many other companies Carlsberg A/S (CPH:CARL B) makes use of debt. But the more important question is: how much risk is that debt creating?

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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. 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 Carlsberg

What Is Carlsberg's Debt?

As you can see below, at the end of June 2020, Carlsberg had kr.29.2b of debt, up from kr.24.6b a year ago. Click the image for more detail. On the flip side, it has kr.7.76b in cash leading to net debt of about kr.21.4b.

How Healthy Is Carlsberg's Balance Sheet?

The latest balance sheet data shows that Carlsberg had liabilities of kr.33.0b due within a year, and liabilities of kr.49.2b falling due after that. Offsetting this, it had kr.7.76b in cash and kr.9.51b in receivables that were due within 12 months. So its liabilities total kr.64.9b more than the combination of its cash and short-term receivables.

Carlsberg has a very large market capitalization of kr.139.1b, so it could very likely raise cash to ameliorate its balance sheet, if the need arose. But we definitely want to keep our eyes open to indications that its debt is bringing too much risk.

We use two main ratios to inform us about debt levels relative to earnings. The first is net debt divided by earnings before interest, tax, depreciation, and amortization (EBITDA), while the second is how many times its earnings before interest and tax (EBIT) covers its interest expense (or its interest cover, for short). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

We'd say that Carlsberg's moderate net debt to EBITDA ratio ( being 1.6), indicates prudence when it comes to debt. And its commanding EBIT of 27.3 times its interest expense, implies the debt load is as light as a peacock feather. On the other hand, Carlsberg saw its EBIT drop by 3.4% in the last twelve months. If earnings continue to decline at that rate the company may have increasing difficulty managing its debt load. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Carlsberg's ability to maintain a healthy balance sheet going forward. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So we always check how much of that EBIT is translated into free cash flow. During the last three years, Carlsberg produced sturdy free cash flow equating to 74% of its EBIT, about what we'd expect. This cold hard cash means it can reduce its debt when it wants to.

Our View

Happily, Carlsberg'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 EBIT growth rate. Looking at all the aforementioned factors together, it strikes us that Carlsberg can handle its debt fairly comfortably. On the plus side, this leverage can boost shareholder returns, but the potential downside is more risk of loss, so it's worth monitoring the balance sheet. 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. Take risks, for example - Carlsberg has 1 warning sign we think you should be aware of.

If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.

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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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