Is Coca-Cola HBC (LON:CCH) A Risky Investment?

By
Simply Wall St
Published
December 17, 2021
LSE:CCH
Source: Shutterstock

Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' 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 Coca-Cola HBC AG (LON:CCH) makes use of debt. But the real question is whether this debt is making the company risky.

When Is Debt A Problem?

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. 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, debt can be an important tool in businesses, particularly capital heavy businesses. The first step when considering a company's debt levels is to consider its cash and debt together.

View our latest analysis for Coca-Cola HBC

How Much Debt Does Coca-Cola HBC Carry?

As you can see below, Coca-Cola HBC had €2.77b of debt, at July 2021, which is about the same as the year before. You can click the chart for greater detail. However, it also had €1.59b in cash, and so its net debt is €1.18b.

debt-equity-history-analysis
LSE:CCH Debt to Equity History December 17th 2021

A Look At Coca-Cola HBC's Liabilities

We can see from the most recent balance sheet that Coca-Cola HBC had liabilities of €2.82b falling due within a year, and liabilities of €2.87b due beyond that. On the other hand, it had cash of €1.59b and €1.11b worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by €2.99b.

This deficit isn't so bad because Coca-Cola HBC is worth a massive €10.7b, 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.

In order to size up a company's debt relative to its earnings, we calculate its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and its earnings before interest and tax (EBIT) divided by its interest expense (its interest cover). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

Coca-Cola HBC's net debt is only 1.1 times its EBITDA. And its EBIT easily covers its interest expense, being 12.7 times the size. So we're pretty relaxed about its super-conservative use of debt. Also positive, Coca-Cola HBC grew its EBIT by 26% in the last year, and that should make it easier to pay down debt, going forward. 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 Coca-Cola HBC'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, a business needs free cash flow to pay off debt; accounting profits just don't cut it. So it's worth checking how much of that EBIT is backed by free cash flow. Over the most recent three years, Coca-Cola HBC recorded free cash flow worth 73% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This free cash flow puts the company in a good position to pay down debt, when appropriate.

Our View

Coca-Cola HBC's interest cover suggests it can handle its debt as easily as Cristiano Ronaldo could score a goal against an under 14's goalkeeper. And that's just the beginning of the good news since its EBIT growth rate is also very heartening. Zooming out, Coca-Cola HBC seems to use debt quite reasonably; and that gets the nod from us. After all, sensible leverage can boost returns on equity. 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. Case in point: We've spotted 3 warning signs for Coca-Cola HBC 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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