Pernod Ricard (EPA:RI) Takes On Some Risk With Its Use Of 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 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. As with many other companies Pernod Ricard SA (EPA:RI) makes use of debt. But should shareholders be worried about its use of debt?

We've discovered 4 warning signs about Pernod Ricard. View them for free.

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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

How Much Debt Does Pernod Ricard Carry?

The image below, which you can click on for greater detail, shows that at December 2024 Pernod Ricard had debt of €13.5b, up from €12.5b in one year. However, it does have €1.92b in cash offsetting this, leading to net debt of about €11.5b.

A Look At Pernod Ricard's Liabilities

Zooming in on the latest balance sheet data, we can see that Pernod Ricard had liabilities of €6.81b due within 12 months and liabilities of €15.4b due beyond that. Offsetting these obligations, it had cash of €1.92b as well as receivables valued at €2.55b due within 12 months. So it has liabilities totalling €17.7b more than its cash and near-term receivables, combined.

This deficit is considerable relative to its very significant market capitalization of €23.2b, so it does suggest shareholders should keep an eye on Pernod Ricard's use of debt. This suggests shareholders would be heavily diluted if the company needed to shore up its balance sheet in a hurry.

View our latest analysis for Pernod Ricard

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). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

Pernod Ricard has a debt to EBITDA ratio of 3.5 and its EBIT covered its interest expense 6.9 times. Taken together this implies that, while we wouldn't want to see debt levels rise, we think it can handle its current leverage. Sadly, Pernod Ricard's EBIT actually dropped 4.1% in the last year. If earnings continue on that decline then managing that debt will be difficult like delivering hot soup on a unicycle. The balance sheet is clearly the area to focus on when you are analysing debt. But it is future earnings, more than anything, that will determine Pernod Ricard'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. So we always check how much of that EBIT is translated into free cash flow. Looking at the most recent three years, Pernod Ricard recorded free cash flow of 34% of its EBIT, which is weaker than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.

Our View

On this analysis Pernod Ricard's net debt to EBITDA and level of total liabilities both make us a little nervous. But the silver lining is its relatively strong interest cover. Looking at the balance sheet and taking into account all these factors, we do believe that debt is making Pernod Ricard stock a bit risky. That's not necessarily a bad thing, but we'd generally feel more comfortable with less leverage. 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. Be aware that Pernod Ricard is showing 4 warning signs in our investment analysis , and 1 of those is concerning...

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

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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.