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Molson Coors Canada (TSE:TPX.B) Use Of Debt Could Be Considered Risky

Simply Wall St

Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' 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. Importantly, Molson Coors Canada Inc. (TSE:TPX.B) does carry debt. But the more important question is: how much risk is that debt creating?

What Risk Does Debt Bring?

Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. 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. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. When we think about a company's use of debt, we first look at cash and debt together.

See our latest analysis for Molson Coors Canada

What Is Molson Coors Canada's Net Debt?

As you can see below, Molson Coors Canada had US$6.24b of debt, at June 2019, which is about the same the year before. You can click the chart for greater detail. However, it also had US$307.5m in cash, and so its net debt is US$5.93b.

TSX:TPX.B Historical Debt, September 16th 2019

How Strong Is Molson Coors Canada's Balance Sheet?

We can see from the most recent balance sheet that Molson Coors Canada had liabilities of US$1.65b falling due within a year, and liabilities of US$7.08b due beyond that. Offsetting these obligations, it had cash of US$307.5m as well as receivables valued at US$511.6m due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by US$7.91b.

The deficiency here weighs heavily on the US$1.02b company itself, as if a child were struggling under the weight of an enormous back-pack full of books, his sports gear, and a trumpet. So we'd watch its balance sheet closely, without a doubt After all, Molson Coors Canada would likely require a major re-capitalisation if it had to pay its creditors today.

We use two main ratios to inform us about debt levels relative to earnings. The first is net debt divided by earnings before interest, tax, depreciation, and amortization (EBITDA), while the second is how many times its earnings before interest and tax (EBIT) covers its interest expense (or its interest cover, for short). The advantage of this approach is that we take into account both the absolute quantum of debt (with net debt to EBITDA) and the actual interest expenses associated with that debt (with its interest cover ratio).

Weak interest cover of 0.26 times and a disturbingly high net debt to EBITDA ratio of 19.6 hit our confidence in Molson Coors Canada like a one-two punch to the gut. This means we'd consider it to have a heavy debt load. Even worse, Molson Coors Canada saw its EBIT tank 59% over the last 12 months. If earnings keep going like that over the long term, it has a snowball's chance in hell of paying off that debt. When analysing debt levels, the balance sheet is the obvious place to start. But it is Molson Coors Canada's earnings that will influence how the balance sheet holds up in the future. So if you're keen to discover more about its earnings, it might be worth checking out this graph of its long term earnings trend.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. So we always check how much of that EBIT is translated into free cash flow. Over the last three years, Molson Coors Canada actually produced more free cash flow than EBIT. There's nothing better than incoming cash when it comes to staying in your lenders' good graces.

Our View

To be frank both Molson Coors Canada's EBIT growth rate and its track record of staying on top of its total liabilities make us rather uncomfortable with its debt levels. But on the bright side, its conversion of EBIT to free cash flow is a good sign, and makes us more optimistic. Taking into account all the aforementioned factors, it looks like Molson Coors Canada has too much debt. While some investors love that sort of risky play, it's certainly not our cup of tea. While Molson Coors Canada didn't make a statutory profit in the last year, its positive EBIT suggests that profitability might not be far away.Click here to see if its earnings are heading in the right direction, over the medium term.

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

We aim to bring you long-term focused research analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material.

If you spot an error that warrants correction, please contact the editor at editorial-team@simplywallst.com. This article by Simply Wall St is general in nature. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. Simply Wall St has no position in the stocks mentioned. Thank you for reading.