These 4 Measures Indicate That Pernod Ricard (EPA:RI) Is Using Debt Extensively

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.' 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 Pernod Ricard SA (EPA:RI) 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?

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. 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. Of course, plenty of companies use debt to fund growth, without any negative consequences. When we examine debt levels, we first consider both cash and debt levels, together.

Check out our latest analysis for Pernod Ricard

What Is Pernod Ricard's Debt?

The image below, which you can click on for greater detail, shows that at December 2023 Pernod Ricard had debt of €12.5b, up from €11.1b in one year. However, it does have €1.64b in cash offsetting this, leading to net debt of about €10.9b.

How Strong Is Pernod Ricard's Balance Sheet?

We can see from the most recent balance sheet that Pernod Ricard had liabilities of €6.79b falling due within a year, and liabilities of €14.7b due beyond that. On the other hand, it had cash of €1.64b and €2.84b worth of receivables due within a year. So it has liabilities totalling €17.1b more than its cash and near-term receivables, combined.

This deficit isn't so bad because Pernod Ricard is worth a massive €36.5b, and thus could probably raise enough capital to shore up 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 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). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

With net debt to EBITDA of 3.4 Pernod Ricard has a fairly noticeable amount of debt. On the plus side, its EBIT was 9.1 times its interest expense, and its net debt to EBITDA, was quite high, at 3.4. The bad news is that Pernod Ricard saw its EBIT decline by 11% over the last year. If earnings continue to decline at that rate then handling the debt will be more difficult than taking three children under 5 to a fancy pants restaurant. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately the future profitability of the business will decide if Pernod Ricard 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, Pernod Ricard's free cash flow amounted to 45% of its EBIT, less than we'd expect. That's not great, when it comes to paying down debt.

Our View

Neither Pernod Ricard's ability to grow its EBIT nor its net debt to EBITDA gave us confidence in its ability to take on more debt. But we do take some comfort from its interest cover. Taking the abovementioned factors together we do think Pernod Ricard's debt poses some risks to the business. While that debt can boost returns, we think the company has enough leverage now. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. These risks can be hard to spot. Every company has them, and we've spotted 2 warning signs for Pernod Ricard (of which 1 is potentially serious!) you should know about.

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. 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.