Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett said “volatility is far from risk.” It is only natural to consider a company’s balance sheet when looking at its level of risk, as debt is often involved when a business collapses. We note that Coca-Cola Europacific Partners SA (AMS: CCEP) has debt on its balance sheet. But should shareholders be concerned about its use of debt?
When is debt dangerous?
Debt helps a business until the business struggles to repay it, either with new capital or with free cash flow. Ultimately, if the company can’t meet its legal debt repayment obligations, shareholders could walk away with nothing. However, a more common (but still painful) scenario is that he must raise new equity at low cost, thereby diluting shareholders over the long term. Of course, the advantage of debt is that it often represents cheap capital, especially when it replaces dilution in a business with the ability to reinvest at high rates of return. When we think of a business’s use of debt, we first look at cash flow and debt together.
See our latest analysis for Coca-Cola Europacific Partners
How much debt do Coca-Cola Europacific partners carry?
You can click on the graph below for historical figures, but it shows that in July 2021, Coca-Cola Europacific Partners had € 12.9 billion in debt, an increase from € 6.76 billion. ‘euros, over one year. However, he also had € 1.82 billion in cash, so his net debt is € 11.1 billion.
A look at the responsibilities of Coca-Cola Europacific Partners
We can see from the most recent balance sheet that Coca-Cola Europacific Partners had liabilities of 6.62 billion euros due within one year and liabilities of 15.8 billion euros due within one year. of the. On the other hand, it had cash of € 1.82 billion and € 2.59 billion in receivables within one year. Its liabilities thus exceed the sum of its cash and its (short-term) receivables by € 18.0 billion.
That’s a mountain of leverage even compared to its gargantuan market capitalization of 22.1 billion euros. If its lenders asked it to consolidate the balance sheet, shareholders would likely face severe dilution.
In order to measure a company’s debt relative to its profits, we calculate its net debt divided by its earnings before interest, taxes, depreciation and amortization (EBITDA) and its profit before interest and taxes (EBIT) divided by its interest. debtors (its interest coverage). The advantage of this approach is that we take into account both the absolute amount of debt (with net debt versus EBITDA) and the actual interest charges associated with this debt (with its coverage rate). interests).
It turns out that Coca-Cola Europacific Partners has a rather worrying net debt to EBITDA ratio of 6.8 but very strong interest coverage of 10.9. So either he has access to very cheap long-term debt or his interest charges will go up! We have seen Coca-Cola Europacific Partners increase its EBIT by 8.1% over the past twelve months. It’s far from incredible, but it’s a good thing when it comes to paying down debt. There is no doubt that we learn the most about debt from the balance sheet. But ultimately, the company’s future profitability will decide whether Coca-Cola Europacific Partners can strengthen its balance sheet over time. So if you are focused on the future you can check this out free report showing analysts’ earnings forecasts.
Finally, a business needs free cash flow to repay its debts; accounting profits are not enough. The logical step is therefore to examine the proportion of this EBIT that corresponds to the actual free cash flow. Fortunately for all shareholders, Coca-Cola Europacific Partners has actually generated more free cash flow than EBIT over the past three years. This kind of strong cash generation warms our hearts like a puppy in a bumblebee costume.
Our point of view
Based on what we have seen, Coca-Cola Europacific Partners does not find it easy, given its net debt to EBITDA, but the other factors we have considered give us cause for optimism. There is no doubt that its ability to convert EBIT into free cash flow is quite fast. Looking at all this data, we feel a little cautious about the debt levels of Coca-Cola Europacific Partners. While we understand that debt can improve returns on equity, we suggest shareholders watch their debt level closely, lest they increase. When analyzing debt levels, the balance sheet is the obvious starting point. But at the end of the day, every business can contain risks that exist off the balance sheet. For example, we have identified 2 warning signs for Coca-Cola Europacific Partners (1 is not doing too well with us) you should be aware of.
At the end of the day, sometimes it’s easier to focus on businesses that don’t even need to go into debt. Readers can access a list of growth stocks with zero net debt 100% free, at present.
This Simply Wall St article is general in nature. We provide commentary based on historical data and analyst forecasts using only unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell shares and does not take into account your goals or your financial situation. Our aim is to bring you long-term, targeted analysis based on fundamental data. Note that our analysis may not take into account the latest announcements from price sensitive companies or qualitative documents. Simply Wall St has no position in any of the stocks mentioned.
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