Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that ‘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. We note that Coca-Cola Europacific Partners PLC (AMS:CCEP) does have debt on its balance sheet. But is this debt a concern to shareholders?

When Is Debt A Problem?

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. Part and parcel of capitalism is the process of ‘creative destruction’ where failed businesses are mercilessly liquidated by their bankers. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. Having said that, the most common situation is where a company manages its debt reasonably well – and to its own advantage. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

See our latest analysis for Coca-Cola Europacific Partners

What Is Coca-Cola Europacific Partners’s Net Debt?

The image below, which you can click on for greater detail, shows that at December 2021 Coca-Cola Europacific Partners had debt of €12.5b, up from €6.86b in one year. However, it also had €1.47b in cash, and so its net debt is €11.1b.

How Strong Is Coca-Cola Europacific Partners’ Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Coca-Cola Europacific Partners had liabilities of €6.09b due within 12 months and liabilities of €15.8b due beyond that. Offsetting these obligations, it had cash of €1.47b as well as receivables valued at €2.66b due within 12 months. So it has liabilities totalling €17.7b more than its cash and near-term receivables, combined.

This is a mountain of leverage even relative to its gargantuan market capitalization of €23.0b. Should its lenders demand that it shore up the balance sheet, shareholders would likely face severe dilution.

In order to size up a company’s debt relative to its earnings, we calculate its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and its earnings before interest and tax (EBIT) divided by its interest expense (its interest cover). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

As it happens Coca-Cola Europacific Partners has a fairly concerning net debt to EBITDA ratio of 5.3 but very strong interest coverage of 14.4. This means that unless the company has access to very cheap debt, that interest expense will likely grow in the future. It is well worth noting that Coca-Cola Europacific Partners’s EBIT shot up like bamboo after rain, gaining 82% in the last twelve months. That’ll make it easier to manage its 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 Coca-Cola Europacific Partners can strengthen its balance sheet over time. So if you’re focused on the future you can check out this free report showing analyst profit forecasts.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. So the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. Over the last three years, Coca-Cola Europacific Partners actually produced more free cash flow than EBIT. That sort of strong cash generation warms our hearts like a puppy in a bumblebee suit.

Our View

The good news is that Coca-Cola Europacific Partners’s demonstrated ability to cover its interest expense with its EBIT delights us like a fluffy puppy does a toddler. But the stark truth is that we are concerned by its net debt to EBITDA. Looking at all the aforementioned factors together, it strikes us that Coca-Cola Europacific Partners can handle its debt fairly comfortably. Of course, while this leverage can enhance returns on equity, it does bring more risk, so it’s worth keeping an eye on this one. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. Case in point: We’ve spotted 2 warning signs for Coca-Cola Europacific Partners you should be aware of, and 1 of them is potentially serious.

If you’re interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.

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This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.