Warren Buffett said: “Volatility is far from synonymous with risk”. When we think about how risky a business is, we always like to look at its use of debt because debt overload can lead to bankruptcy. Like many other companies Emmi SA (VTX: EMMN) uses debt. But should shareholders be concerned about its use of debt?
What risk does debt entail?
Generally speaking, debt only becomes a real problem when a company cannot repay it easily, either by raising capital or with its own cash flow. An integral part of capitalism is the process of “creative destruction” where bankrupt companies are ruthlessly liquidated by their bankers. However, a more common (but still painful) scenario is that he has to raise new equity at low cost, thereby constantly diluting shareholders. Of course, the advantage of debt is that it often represents cheap capital, especially when it replaces dilution of 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.
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How much debt does Emmi have?
You can click on the graph below for the historical figures, but it shows that Emmi had a debt of CHF 460.9 million in June 2021, up from CHF 492.6 million a year earlier. On the other hand, it has 251.4 million Swiss francs in cash, resulting in a net debt of around 209.5 million Swiss francs.
How healthy is Emmi’s track record?
Zooming in on the latest balance sheet data, we can see that Emmi had a liability of 602.4 million francs due within 12 months and a liability of 510.0 million francs beyond. In compensation for these obligations, he had cash of CHF 251.4 million as well as receivables valued at CHF 502.8 million within 12 months. Its liabilities therefore exceed the sum of its cash and (short-term) receivables by CHF 358.3 million.
Given that Emmi has a market cap of 5.63 billion Swiss francs, it’s hard to believe that these liabilities pose a significant threat. Having said that, it is clear that we must continue to monitor his record lest it get worse.
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).
Emmi has a low net debt to EBITDA ratio of just 0.48. And its EBIT easily covers its interest costs, being 73.5 times higher. We could therefore say that he is no more threatened by his debt than an elephant is by a mouse. Also positive, Emmi has increased its EBIT by 20% over the past year, which should make it easier to pay down debt going forward. There is no doubt that we learn the most about debt from the balance sheet. But it’s future earnings, more than anything, that will determine Emmi’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 Analyst Profit Forecast report interesting.
But our last consideration is also important, because a business cannot pay its debts with paper profits; he needs hard cash. The logical step is therefore to examine the proportion of this EBIT that corresponds to the actual free cash flow. Over the past three years, Emmi has generated strong free cash flow equivalent to 73% of its EBIT, roughly what we expected. This free cash flow puts the business in a good position to repay debt, if any.
Our point of view
The good news is that Emmi’s demonstrated ability to cover her interest costs with her EBIT delights us like a fluffy puppy does a toddler. And the good news does not end there, since its conversion of EBIT into free cash flow also confirms this impression! Overall, we don’t think Emmi is taking bad risks, as her debt load appears modest. The balance sheet therefore seems rather healthy to us. On top of most other metrics, we think it’s important to track how quickly earnings per share are growing, if at all. If you have understood this as well, you are in luck because today you can check out this interactive chart of historical Emmi earnings per share for free.
If you want to invest in companies that can generate profits without the burden of debt, check out this free list of growing companies that have net cash on the balance sheet.
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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 any stock 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 material. Simply Wall St has no position in any of the stocks mentioned.