We Think Davide Campari-Milano (BIT:CPR) Can Stay On Top Of Its Debt

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. It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. As with many other companies Davide Campari-Milano S.p.A. (BIT:CPR) makes use of debt. But should shareholders be worried about its use of debt?

Why Does Debt Bring Risk?

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. 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, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. When we think about a company's use of debt, we first look at cash and debt together.

View our latest analysis for Davide Campari-Milano

How Much Debt Does Davide Campari-Milano Carry?

As you can see below, at the end of June 2019, Davide Campari-Milano had €1.64b of debt, up from €1.5k a year ago. Click the image for more detail. On the flip side, it has €772.5m in cash leading to net debt of about €867.0m.

How Strong Is Davide Campari-Milano's Balance Sheet?

We can see from the most recent balance sheet that Davide Campari-Milano had liabilities of €677.7m falling due within a year, and liabilities of €1.95b due beyond that. On the other hand, it had cash of €772.5m and €346.1m worth of receivables due within a year. So its liabilities total €1.51b more than the combination of its cash and short-term receivables.

Of course, Davide Campari-Milano has a titanic market capitalization of €9.97b, so these liabilities are probably manageable. Having said that, it's clear that we should continue to monitor its balance sheet, lest it change for the worse.

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.

Davide Campari-Milano's net debt to EBITDA ratio of about 2.0 suggests only moderate use of debt. And its strong interest cover of 13.7 times, makes us even more comfortable. The bad news is that Davide Campari-Milano saw its EBIT decline by 13% 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. There's no doubt that we learn most about debt from the balance sheet. But it is future earnings, more than anything, that will determine Davide Campari-Milano'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. During the last three years, Davide Campari-Milano produced sturdy free cash flow equating to 55% of its EBIT, about what we'd expect. This free cash flow puts the company in a good position to pay down debt, when appropriate.

Our View

On our analysis Davide Campari-Milano's interest cover should signal that it won't have too much trouble with its debt. But the other factors we noted above weren't so encouraging. To be specific, it seems about as good at (not) growing its EBIT as wet socks are at keeping your feet warm. When we consider all the factors mentioned above, we do feel a bit cautious about Davide Campari-Milano's use of debt. While debt does have its upside in higher potential returns, we think shareholders should definitely consider how debt levels might make the stock more risky. 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. To that end, you should learn about the 3 warning signs we've spotted with Davide Campari-Milano (including 1 which is is a bit unpleasant) .

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

If you spot an error that warrants correction, please contact the editor at editorial-team@simplywallst.com. This article by Simply Wall St is general in nature. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. Simply Wall St has no position in the stocks mentioned.

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