Coloplast (CPH:COLO B) seems to use debt sparingly
Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett said “volatility is far from synonymous with risk.” So it may be obvious that you need to take debt into account when thinking about the risk of a given stock, because too much debt can sink a business. Like many other companies Coloplast A/S (CPH:COLO B) uses debt. But should shareholders worry about its use of debt?
What risk does debt carry?
Debt and other liabilities become risky for a business when it cannot easily meet those obligations, either with free cash flow or by raising capital at an attractive price. An integral part of capitalism is the process of “creative destruction” where bankrupt companies are mercilessly liquidated by their bankers. Although not too common, we often see companies in debt permanently diluting their shareholders because lenders force them to raise capital at a ridiculous price. By replacing dilution, however, debt can be a great tool for companies 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 review for Coloplast
What is Coloplast’s debt?
You can click on the graph below for historical figures, but it shows that in December 2021, Coloplast had a debt of 4.44 billion kr, an increase from 4.02 billion kr, year on year . However, as it has a cash reserve of 864.0 million kr, its net debt is less at around 3.57 billion kr.
How strong is Coloplast’s balance sheet?
Zooming in on the latest balance sheet data, we can see that Coloplast had liabilities of 8.48 billion kr due within 12 months and liabilities of 1.29 billion kr due beyond. As compensation for these obligations, it had liquid assets of 864.0 million kr as well as receivables valued at 3.74 billion kr and payable within 12 months. Thus, its liabilities total kr 5.16 billion more than the combination of its cash and short-term receivables.
Given that Coloplast has a colossal market capitalization of 227.9 billion kr, it is hard to believe that these liabilities pose a threat. That said, it is clear that we must continue to monitor its record, lest it deteriorate.
We measure a company’s leverage against its earning power by looking at its net debt divided by its earnings before interest, taxes, depreciation and amortization (EBITDA) and calculating how easily its earnings before interest and taxes (EBIT ) covers its interest charge (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 ).
Coloplast has a low net debt to EBITDA ratio of just 0.51. And its EBIT covers its interest charges 496 times. One could therefore say that he is no more threatened by his debt than an elephant is by a mouse. The good news is that Coloplast increased its EBIT by 9.0% year-over-year, which should ease any debt repayment concerns. When analyzing debt levels, the balance sheet is the obvious starting point. But ultimately, the company’s future profitability will decide whether Coloplast can strengthen its balance sheet over time. So if you are focused on the future, you can check out this free report showing analyst earnings forecast.
But our last consideration is also important, because a company cannot pay debt with paper profits; he needs cash. We must therefore clearly examine whether this EBIT generates a corresponding free cash flow. Over the past three years, Coloplast has recorded free cash flow of 61% of its EBIT, which is about normal, given that free cash flow excludes interest and taxes. This cold hard cash allows him to reduce his debt whenever he wants.
Our point of view
Fortunately, Coloplast’s impressive interest coverage means it has the upper hand on its debt. And the good news does not stop there, since its net debt to EBITDA also confirms this impression! It should also be noted that Coloplast is in the medical equipment industry, which is often seen as quite defensive. Zooming out, Coloplast appears to be using debt quite sensibly; and that gets the green light from us. After all, reasonable leverage can increase return on equity. There is no doubt that we learn the most about debt from the balance sheet. However, not all investment risks reside on the balance sheet, far from it. Know that Coloplast shows 2 warning signs in our investment analysis you should know…
Of course, if you’re the type of investor who prefers to buy stocks without the burden of debt, then feel free to check out our exclusive list of cash-efficient growth stocks today.
Feedback on this article? Concerned about content? Get in touch with us directly. You can also email the editorial team (at) Simplywallst.com.
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.