Varun Beverages (NSE:VBL) Has A Pretty Healthy Balance Sheet

By
Simply Wall St
Published
March 18, 2022
NSEI:VBL
Source: Shutterstock

Warren Buffett famously said, 'Volatility is far from synonymous with risk.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. Importantly, Varun Beverages Limited (NSE:VBL) does carry debt. But should shareholders be worried about its use of debt?

What Risk Does Debt Bring?

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 usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. 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.

See our latest analysis for Varun Beverages

What Is Varun Beverages's Debt?

The image below, which you can click on for greater detail, shows that at December 2021 Varun Beverages had debt of ₹33.4b, up from ₹32.1b in one year. However, because it has a cash reserve of ₹1.51b, its net debt is less, at about ₹31.9b.

debt-equity-history-analysis
NSEI:VBL Debt to Equity History March 18th 2022

How Strong Is Varun Beverages' Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Varun Beverages had liabilities of ₹30.2b due within 12 months and liabilities of ₹23.6b due beyond that. On the other hand, it had cash of ₹1.51b and ₹4.58b worth of receivables due within a year. So its liabilities total ₹47.8b more than the combination of its cash and short-term receivables.

Of course, Varun Beverages has a market capitalization of ₹410.5b, so these liabilities are probably manageable. But there are sufficient liabilities that we would certainly recommend shareholders continue to monitor the balance sheet, going forward.

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). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

Varun Beverages has net debt worth 1.9 times EBITDA, which isn't too much, but its interest cover looks a bit on the low side, with EBIT at only 6.8 times the interest expense. While these numbers do not alarm us, it's worth noting that the cost of the company's debt is having a real impact. Importantly, Varun Beverages grew its EBIT by 64% over the last twelve months, and that growth will make it easier to handle its debt. There's no doubt that we learn most about debt from the balance sheet. But ultimately the future profitability of the business will decide if Varun Beverages 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, a business needs free cash flow to pay off debt; accounting profits just don't cut it. So we always check how much of that EBIT is translated into free cash flow. In the last three years, Varun Beverages's free cash flow amounted to 48% of its EBIT, less than we'd expect. That's not great, when it comes to paying down debt.

Our View

Happily, Varun Beverages's impressive EBIT growth rate implies it has the upper hand on its debt. And we also thought its interest cover was a positive. Taking all this data into account, it seems to us that Varun Beverages takes a pretty sensible approach to debt. While that brings some risk, it can also enhance returns for shareholders. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. For example - Varun Beverages has 1 warning sign we think 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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