We believe Givaudan (VTX: GIVN) can stay on top of its debt

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Some say volatility, rather than debt, is the best way to view risk as an investor, but Warren Buffett said “volatility is far from risk.” So it can be obvious that you need to consider debt, when you think about how risky a given stock is because too much debt can sink a business. We can see that Givaudan SA (VTX: GIVN) uses debt in its business. But does this debt worry shareholders?

When is debt a problem?

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. If things really go wrong, lenders can take over the business. However, a more common (but still costly) event is when a company has to issue stock at bargain prices, constantly diluting shareholders, just to strengthen its balance sheet. Of course, many companies use debt to finance their growth without negative consequences. The first thing to do when considering how much debt a business uses is to look at its cash flow and debt together.

Discover our latest analysis for Givaudan

What is Givaudan’s debt?

The graph below, which you can click for more details, shows that Givaudan had a debt of 4.60 billion francs in June 2021; about the same as the year before. However, given that it has a cash reserve of CHF 310.0 million, its net debt is lower, at around CHF 4.29 billion.

SWX: GIVN History of debt to equity October 25, 2021

Is Givaudan’s track record healthy?

According to the last published balance sheet, Givaudan had liabilities of 2.41 billion francs at less than 12 months and liabilities of 5.26 billion francs at more than 12 months. On the other hand, it had cash of CHF 310.0 million and CHF 1.81 billion in receivables within one year. As a result, its debts exceed the sum of its cash and (short-term) receivables by CHF 5.55 billion.

Considering that Givaudan has a whopping market capitalization of CHF 39.7 billion, it’s hard to believe that these liabilities pose a significant threat. But there are enough liabilities that we would certainly recommend that shareholders continue to monitor the balance sheet going forward.

We use two main ratios to inform us about the levels of debt compared to earnings. The first is net debt divided by earnings before interest, taxes, depreciation, and amortization (EBITDA), while the second is the number of times its profit before interest and taxes (EBIT) covers its interest expense (or its coverage of interest, for short). Thus, we look at debt over earnings with and without amortization charges.

Givaudan’s net debt is 3.1 times its EBITDA, which represents significant leverage but still reasonable. However, its interest coverage of 12.8 is very high, suggesting that interest charges on debt are currently quite low. Givaudan increased its EBIT by 9.9% last year. 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 Givaudan 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 can only repay its debts with hard cash, not with book profits. 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, Givaudan has generated free cash flow of a very strong 85% of its EBIT, more than we expected. This positions it well to repay debt if it is desirable.

Our point of view

The good news is that Givaudan’s demonstrated ability to cover its interest costs with its EBIT delights us like a fluffy puppy does a toddler. But, on a darker note, we’re a little concerned about its net debt to EBITDA. Overall, we think Givaudan’s use of debt seems quite reasonable and we are not concerned about that. After all, reasonable leverage can increase returns on equity. When analyzing debt levels, the balance sheet is the obvious starting point. However, not all investment risks lie on the balance sheet – far from it. For example, we have identified 1 warning sign for Givaudan that you need to be aware of.

At the end of the day, it’s often best to focus on businesses with no net debt. You can access our special list of these companies (all with a history of profit growth). It’s free.

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 material. Simply Wall St has no position in any of the stocks mentioned.

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