Royal Unibrew (CPH:RBREW) seems to be using debt quite wisely
Howard Marks said it well when he said that, rather than worrying about stock price volatility, “the possibility of permanent loss is the risk I worry about…and that every practical investor that I know is worried”. So it seems smart money knows that debt – which is usually involved in bankruptcies – is a very important factor when you’re assessing a company’s risk. Above all, Royal Unibrew A/S (CPH:RBREW) is in debt. But does this debt worry shareholders?
Why is debt risky?
Debt is a tool to help businesses grow, but if a business is unable to repay its lenders, it exists at their mercy. Ultimately, if the company cannot meet its legal debt repayment obligations, shareholders could walk away with nothing. However, a more common (but still costly) situation is when a company has to dilute shareholders at a cheap share price just to keep debt under control. Of course, debt can be an important tool in businesses, especially capital-intensive businesses. When we think about a company’s use of debt, we first look at cash and debt together.
Check out our latest analysis for Royal Unibrew
What is Royal Unibrew’s debt?
You can click on the graph below for historical figures, but it shows that in September 2021, Royal Unibrew had a debt of 3.60 billion kr, an increase from 1.95 billion kr, on a year. However, as it has a cash reserve of 199.0 million kr, its net debt is less at around 3.40 billion kr.
A look at Royal Unibrew’s responsibilities
We can see from the most recent balance sheet that Royal Unibrew had liabilities of 4.36 billion kr due in one year and liabilities of 3.19 billion kr due beyond. As compensation for these obligations, it had liquid assets of 199.0 million kr as well as receivables valued at 1.16 billion kr and payable within 12 months. Thus, its liabilities outweigh the sum of its cash and (short-term) receivables of 6.20 billion kr.
Of course, Royal Unibrew has a market capitalization of 37.9 billion kr, so these liabilities are probably manageable. However, we think it’s worth keeping an eye on the strength of its balance sheet, as it can change over time.
We use two main ratios to inform us about debt to earnings levels. The first is net debt divided by earnings before interest, taxes, depreciation and amortization (EBITDA), while the second is how often its earnings before interest and taxes (EBIT) covers its interest expense (or its interests, for short). Thus, we consider debt to earnings with and without amortization and depreciation expense.
Royal Unibrew’s net debt to EBITDA ratio of around 1.7 suggests only moderate use of debt. And its towering EBIT of 51.5 times its interest expense means that the debt burden is as light as a peacock feather. We have seen Royal Unibrew increase its EBIT by 4.3% over the last twelve months. While that barely brings us down, it’s a positive when it comes to debt. The balance sheet is clearly the area to focus on when analyzing debt. But it is future earnings, more than anything, that will determine Royal Unibrew’s ability to maintain a healthy balance sheet in the future. So if you want to see what the professionals think, you might find this free analyst earnings forecast report interesting.
Finally, while the taxman may love accounting profits, lenders only accept cash. So the logical step is to look at what proportion of that EBIT is actual free cash flow. Over the past three years, Royal Unibrew has generated free cash flow of a very strong 82% of its EBIT, more than expected. This positions him well to pay off debt if desired.
Our point of view
The good news is that Royal Unibrew’s demonstrated ability to cover its interest costs with its EBIT delights us like a fluffy puppy does a toddler. And the good news does not stop there, since its conversion of EBIT into free cash flow also confirms this impression! Zooming out, Royal Unibrew seems to be using debt quite sensibly; and that gets the green light from us. Although debt carries risks, when used wisely, it can also generate a higher return on equity. The balance sheet is clearly the area to focus on when analyzing debt. But at the end of the day, every business can contain risks that exist outside of the balance sheet. These risks can be difficult to spot. Every business has them, and we’ve spotted 2 warning signs for Royal Unibrew you should know.
If you are interested in investing in companies that can generate profits without the burden of debt, then 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 only using unbiased methodology and our articles are not intended to be financial advice. It is not a recommendation to buy or sell stocks and does not take into account your objectives or financial situation. Our goal is to bring you targeted long-term analysis based on fundamental data. Note that our analysis may not take into account the latest announcements from price-sensitive companies or qualitative materials. Simply Wall St has no position in the stocks mentioned.