David Iben said it well when he said: “Volatility is not a risk that interests us. What matters to us is to avoid the permanent loss of capital. It’s natural to consider a company’s balance sheet when looking at its riskiness, as debt is often involved when a company fails. Like many other companies Nestlé SA (VTX:NESN) uses debt. But does this debt worry shareholders?
When is debt a problem?
Debt is a tool to help businesses grow, but if a business is unable to repay its lenders, it exists at their mercy. In the worst case, a company can go bankrupt if it cannot pay its creditors. However, a more common (but still painful) scenario is that it has to raise new equity at a low price, thereby permanently diluting shareholders. By replacing dilution, however, debt can be a great tool for companies that need capital to invest in growth at high rates of return. The first step when considering a company’s debt levels is to consider its cash and debt together.
See our latest analysis for Nestlé
What is Nestlé’s debt?
The image below, which you can click on for more details, shows that in December 2021, Nestlé had a debt of CHF 44.0 billion, compared to CHF 37.3 billion in one year. However, it has 14.0 billion francs of cash to offset this, resulting in a net debt of approximately 29.9 billion francs.
A look at Nestlé’s liabilities
We can see from the most recent balance sheet that Nestlé had liabilities of CHF 40.0 billion due in one year, and liabilities of CHF 45.4 billion due beyond. On the other hand, it had 14.0 billion francs in cash and 12.4 billion francs in receivables at less than one year. It therefore has liabilities totaling 59.0 billion francs more than its cash and short-term receivables, combined.
Given that Nestlé has a colossal market capitalization of CHF 326.2 billion, it’s hard to believe that these liabilities pose a threat. But there are enough liabilities that we certainly recommend that shareholders continue to monitor the balance sheet in the future.
In order to assess a company’s debt relative to its earnings, we calculate its net debt divided by its earnings before interest, taxes, depreciation and amortization (EBITDA) and its earnings before interest and taxes (EBIT) divided by its expenses. interest (its interest coverage). The advantage of this approach is that we consider both the absolute amount of debt (with net debt to EBITDA) and the actual interest expense associated with that debt (with its interest coverage ratio ).
Nestlé’s net debt to EBITDA ratio of around 1.7 suggests only moderate reliance on debt. And its towering EBIT of 19.3 times its interest expense means that the debt burden is as light as a peacock feather. We have seen Nestlé increase its EBIT by 4.3% over the last twelve months. It’s far from amazing, but it’s a good thing when it comes to paying down debt. When analyzing debt levels, the balance sheet is the obvious starting point. But it is future earnings, more than anything, that will determine Nestlé’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, a company can only repay its debts with cold hard cash, not with book profits. So the logical step is to look at what proportion of that EBIT is actual free cash flow. Over the past three years, Nestlé has produced strong free cash flow equivalent to 67% of its EBIT, which is what we expected. This cold hard cash allows him to reduce his debt whenever he wants.
Our point of view
Fortunately, Nestlé’s impressive interest coverage means it has the upper hand on its debt. And the good news does not stop there, since its conversion of EBIT into free cash flow also confirms this impression! Given all this data, it seems to us that Nestlé has a pretty sensible approach to debt. While this carries some risk, it can also improve shareholder returns. 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. We have identified 2 warning signs with Nestlé (at least 1, which is significant), and understanding them should be part of your investment process.
If, after all that, you’re more interested in a fast-growing company with a strong balance sheet, check out our list of cash-neutral growth stocks right away.
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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.