These 4 Measures Indicate That Coca-Cola (NYSE:KO) Is Using Debt Reasonably Well

Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk.' 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. Importantly, The Coca-Cola Company (NYSE:KO) does carry debt. But the more important question is: how much risk is that debt creating?

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. 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 Coca-Cola

What Is Coca-Cola's Net Debt?

As you can see below, at the end of September 2024, Coca-Cola had US$47.1b of debt, up from US$41.8b a year ago. Click the image for more detail. On the flip side, it has US$18.2b in cash leading to net debt of about US$29.0b.

How Strong Is Coca-Cola's Balance Sheet?

The latest balance sheet data shows that Coca-Cola had liabilities of US$28.6b due within a year, and liabilities of US$49.5b falling due after that. Offsetting these obligations, it had cash of US$18.2b as well as receivables valued at US$4.23b due within 12 months. So it has liabilities totalling US$55.7b more than its cash and near-term receivables, combined.

This deficit isn't so bad because Coca-Cola is worth a massive US$265.8b, 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). The advantage of this approach is that we take into account both the absolute quantum of debt (with net debt to EBITDA) and the actual interest expenses associated with that debt (with its interest cover ratio).

Coca-Cola's net debt to EBITDA ratio of about 2.0 suggests only moderate use of debt. And its commanding EBIT of 34.1 times its interest expense, implies the debt load is as light as a peacock feather. We saw Coca-Cola grow its EBIT by 5.2% in the last twelve months. Whilst that hardly knocks our socks off it is a positive when it comes to debt. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Coca-Cola can strengthen its balance sheet over time. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. So we always check how much of that EBIT is translated into free cash flow. Over the most recent three years, Coca-Cola recorded free cash flow worth 60% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This cold hard cash means it can reduce its debt when it wants to.

Our View

Happily, Coca-Cola's impressive interest cover implies it has the upper hand on its debt. And its conversion of EBIT to free cash flow is good too. All these things considered, it appears that Coca-Cola can comfortably handle its current debt levels. On the plus side, this leverage can boost shareholder returns, but the potential downside is more risk of loss, so it's worth monitoring the balance sheet. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. For instance, we've identified 3 warning signs for Coca-Cola (1 is a bit concerning) you should be aware of.

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.