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. 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. We note that Givaudan SA (VTX:GIVN) does have debt on its balance sheet. But the more important question is: how much risk is that debt creating?
When Is Debt Dangerous?
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. If things get really bad, the lenders can take control of the business. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we think about a company's use of debt, we first look at cash and debt together.
Check out our latest analysis for Givaudan
What Is Givaudan's Debt?
The image below, which you can click on for greater detail, shows that at June 2019 Givaudan had debt of CHF3.54b, up from CHF2.63b in one year. However, it also had CHF242.0m in cash, and so its net debt is CHF3.30b.
How Strong Is Givaudan's Balance Sheet?
According to the last reported balance sheet, Givaudan had liabilities of CHF2.09b due within 12 months, and liabilities of CHF4.32b due beyond 12 months. Offsetting this, it had CHF242.0m in cash and CHF1.62b in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by CHF4.55b.
Since publicly traded Givaudan shares are worth a very impressive total of CHF25.5b, it seems unlikely that this level of liabilities would be a major threat. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time.
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). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.
Givaudan's net debt is 2.9 times its EBITDA, which is a significant but still reasonable amount of leverage. However, its interest coverage of 15.8 is very high, suggesting that the interest expense may well rise in the future, even if there hasn't yet been a major cost attached to that debt. Givaudan grew its EBIT by 2.7% in the last year. 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 Givaudan 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.