Constellation Brands (NYSE:STZ) Seems To Use Debt Quite Sensibly

<p class="canvas-atom canvas-text Mb(1.0em) Mb(0)–sm Mt(0.8em)–sm" type="text" content="Warren Buffett famously said, 'Volatility is far from synonymous with risk.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. We can see that Constellation Brands, Inc. (NYSE:STZ) does use debt in its business. But should shareholders be worried about its use of debt?” data-reactid=”18″>Warren Buffett famously said, ‘Volatility is far from synonymous with risk.’ It’s only natural to consider a company’s balance sheet when you examine how risky it is, since debt is often involved when a business collapses. We can see that Constellation Brands, Inc. (NYSE:STZ) does use debt in its business. But should shareholders be worried about its use of debt?

Why Does Debt Bring Risk?

Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. Part and parcel of capitalism is the process of ‘creative destruction’ where failed businesses are mercilessly liquidated by their bankers. 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. Having said that, the most common situation is where a company manages its debt reasonably well – and to its own advantage. When we think about a company’s use of debt, we first look at cash and debt together.

<p class="canvas-atom canvas-text Mb(1.0em) Mb(0)–sm Mt(0.8em)–sm" type="text" content=" Check out our latest analysis for Constellation Brands ” data-reactid=”21″>Check out our latest analysis for Constellation Brands

What Is Constellation Brands’s Debt?

The image below, which you can click on for greater detail, shows that at May 2019 Constellation Brands had debt of US$13.4b, up from US$10.1b in one year. Net debt is about the same, since the it doesn’t have much cash.

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A Look At Constellation Brands’s Liabilities

The latest balance sheet data shows that Constellation Brands had liabilities of US$2.94b due within a year, and liabilities of US$13.5b falling due after that. On the other hand, it had cash of US$98.7m and US$788.3m worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by US$15.6b.

Constellation Brands has a very large market capitalization of US$38.9b, so it could very likely raise cash to ameliorate its balance sheet, if the need arose. But we definitely want to keep our eyes open to indications that its debt is bringing too much risk.

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). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

<p class="canvas-atom canvas-text Mb(1.0em) Mb(0)–sm Mt(0.8em)–sm" type="text" content="Constellation Brands's debt is 4.4 times its EBITDA, and its EBIT cover its interest expense 6.8 times over. This suggests that while the debt levels are significant, we'd stop short of calling them problematic. One way Constellation Brands could vanquish its debt would be if it stops borrowing more but conitinues to grow EBIT at around 11%, as it did over the last year. There's no doubt that we learn most about debt from the balance sheet. But it is future earnings, more than anything, that will determine Constellation Brands's ability to maintain a healthy balance sheet going forward. So if you're focused on the future you can check out this free report showing analyst profit forecasts.” data-reactid=”40″>Constellation Brands’s debt is 4.4 times its EBITDA, and its EBIT cover its interest expense 6.8 times over. This suggests that while the debt levels are significant, we’d stop short of calling them problematic. One way Constellation Brands could vanquish its debt would be if it stops borrowing more but conitinues to grow EBIT at around 11%, as it did over the last year. There’s no doubt that we learn most about debt from the balance sheet. But it is future earnings, more than anything, that will determine Constellation Brands’s ability to maintain a healthy balance sheet going forward. 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. Looking at the most recent three years, Constellation Brands recorded free cash flow of 44% of its EBIT, which is weaker than we’d expect. That weak cash conversion makes it more difficult to handle indebtedness.