Is British American Tobacco (LON:BATS) Using Debt In A Risky Way?

David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the permanent loss of capital.' 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 British American Tobacco p.l.c. (LON:BATS) makes use of debt. But should shareholders be worried about its use of debt?

When Is Debt Dangerous?

Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. 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. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

View our latest analysis for British American Tobacco

What Is British American Tobacco's Debt?

As you can see below, British American Tobacco had UK£39.2b of debt at December 2023, down from UK£42.6b a year prior. On the flip side, it has UK£5.26b in cash leading to net debt of about UK£34.0b.

How Strong Is British American Tobacco's Balance Sheet?

According to the last reported balance sheet, British American Tobacco had liabilities of UK£15.7b due within 12 months, and liabilities of UK£50.1b due beyond 12 months. Offsetting this, it had UK£5.26b in cash and UK£3.79b in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by UK£56.7b.

When you consider that this deficiency exceeds the company's huge UK£55.4b market capitalization, you might well be inclined to review the balance sheet intently. In the scenario where the company had to clean up its balance sheet quickly, it seems likely shareholders would suffer extensive dilution. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if British American Tobacco 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.

Over 12 months, British American Tobacco saw its revenue hold pretty steady, and it did not report positive earnings before interest and tax. While that's not too bad, we'd prefer see growth.

Caveat Emptor

Over the last twelve months British American Tobacco produced an earnings before interest and tax (EBIT) loss. Indeed, it lost a very considerable UK£11b at the EBIT level. When we look at that alongside the significant liabilities, we're not particularly confident about the company. We'd want to see some strong near-term improvements before getting too interested in the stock. It's fair to say the loss of UK£14b didn't encourage us either; we'd like to see a profit. In the meantime, we consider the stock to be risky. 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. For example, we've discovered 2 warning signs for British American Tobacco that you should be aware of before investing here.

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.