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Warren Buffett famously said, '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. As with many other companies Coca-Cola Amatil Limited (ASX:CCL) makes use of debt. But the real question is whether this debt is making the company risky.
When Is Debt Dangerous?
Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. Of course, plenty of companies use debt to fund growth, without any negative consequences. When we think about a company's use of debt, we first look at cash and debt together.
View our latest analysis for Coca-Cola Amatil
What Is Coca-Cola Amatil's Debt?
The image below, which you can click on for greater detail, shows that Coca-Cola Amatil had debt of AU$2.35b at the end of June 2019, a reduction from AU$2.48b over a year. On the flip side, it has AU$938.8m in cash leading to net debt of about AU$1.41b.
How Healthy Is Coca-Cola Amatil's Balance Sheet?
The latest balance sheet data shows that Coca-Cola Amatil had liabilities of AU$1.68b due within a year, and liabilities of AU$2.78b falling due after that. Offsetting these obligations, it had cash of AU$938.8m as well as receivables valued at AU$837.1m due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by AU$2.68b.
This deficit isn't so bad because Coca-Cola Amatil is worth AU$7.87b, and thus could probably raise enough capital to shore up its balance sheet, if the need arose. However, it is still worthwhile taking a close look at its ability to pay off debt.
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). 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).
With a debt to EBITDA ratio of 1.5, Coca-Cola Amatil uses debt artfully but responsibly. And the fact that its trailing twelve months of EBIT was 9.8 times its interest expenses harmonizes with that theme. Unfortunately, Coca-Cola Amatil saw its EBIT slide 9.9% in the last twelve months. If earnings continue on that decline then managing that debt will be difficult like delivering hot soup on a unicycle. 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 Amatil 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.