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.' 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?

When Is Debt Dangerous?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. If things get really bad, the lenders can take control of the business. 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. Of course, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. When we examine debt levels, we first consider both cash and debt levels, together.

How Much Debt Does Constellation Brands Carry?

The image below, which you can click on for greater detail, shows that Constellation Brands had debt of US$11.9b at the end of February 2024, a reduction from US$12.4b over a year. Net debt is about the same, since the it doesn't have much cash.

How Healthy Is Constellation Brands' Balance Sheet?

The latest balance sheet data shows that Constellation Brands had liabilities of US$3.14b due within a year, and liabilities of US$12.5b falling due after that. Offsetting this, it had US$152.4m in cash and US$1.08b in receivables that were due within 12 months. So its liabilities total US$14.4b more than the combination of its cash and short-term receivables.

Constellation Brands has a very large market capitalization of US$47.9b, so it could very likely raise cash to ameliorate its balance sheet, if the need arose. However, it is still worthwhile taking a close look at its ability to pay off debt.

We measure a company's debt load relative to its earnings power by looking at its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and by calculating how easily its earnings before interest and tax (EBIT) cover its interest expense (interest cover). 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).

Constellation Brands has net debt to EBITDA of 3.2 suggesting it uses a fair bit of leverage to boost returns. On the plus side, its EBIT was 7.3 times its interest expense, and its net debt to EBITDA, was quite high, at 3.2. Constellation Brands grew its EBIT by 7.3% in the last year. Whilst that hardly knocks our socks off it is a positive when it comes to debt. There's no doubt that we learn most about debt from the balance sheet. But ultimately the future profitability of the business will decide if Constellation Brands 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 it's worth checking how much of that EBIT is backed by free cash flow. Over the most recent three years, Constellation Brands recorded free cash flow worth 53% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This free cash flow puts the company in a good position to pay down debt, when appropriate.

Our View

Constellation Brands's interest cover was a real positive on this analysis, as was its EBIT growth rate. On the other hand, its net debt to EBITDA makes us a little less comfortable about its debt. Looking at all this data makes us feel a little cautious about Constellation Brands's debt levels. While debt does have its upside in higher potential returns, we think shareholders should definitely consider how debt levels might make the stock more risky. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. For example - Constellation Brands has 3 warning signs we think you should be aware of.

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.

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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.