These 4 Measures Indicate That Coles Group (ASX:COL) Is Using Debt Reasonably Well

Warren Buffett famously said, '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. As with many other companies Coles Group Limited (ASX:COL) makes use of debt. But is this debt a concern to shareholders?

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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. If things get really bad, the lenders can take control of the business. 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. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. When we think about a company's use of debt, we first look at cash and debt together.

How Much Debt Does Coles Group Carry?

You can click the graphic below for the historical numbers, but it shows that as of January 2025 Coles Group had AU$2.28b of debt, an increase on AU$1.67b, over one year. However, it also had AU$625.0m in cash, and so its net debt is AU$1.65b.

How Strong Is Coles Group's Balance Sheet?

The latest balance sheet data shows that Coles Group had liabilities of AU$6.42b due within a year, and liabilities of AU$10.0b falling due after that. Offsetting these obligations, it had cash of AU$625.0m as well as receivables valued at AU$500.0m due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by AU$15.3b.

While this might seem like a lot, it is not so bad since Coles Group has a huge market capitalization of AU$27.9b, and so it could probably strengthen its balance sheet by raising capital if it needed to. But it's clear that we should definitely closely examine whether it can manage its debt without dilution.

See our latest analysis for Coles Group

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.

While Coles Group's low debt to EBITDA ratio of 0.61 suggests only modest use of debt, the fact that EBIT only covered the interest expense by 4.2 times last year does give us pause. But the interest payments are certainly sufficient to have us thinking about how affordable its debt is. If Coles Group can keep growing EBIT at last year's rate of 17% over the last year, then it will find its debt load easier to manage. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Coles Group can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. Over the most recent three years, Coles Group recorded free cash flow worth 52% 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

Both Coles Group's ability to handle its debt, based on its EBITDA, and its EBIT growth rate gave us comfort that it can handle its debt. Having said that, its interest cover somewhat sensitizes us to potential future risks to the balance sheet. When we consider all the elements mentioned above, it seems to us that Coles Group is managing its debt quite well. Having said that, the load is sufficiently heavy that we would recommend any shareholders keep a close eye on it. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. For instance, we've identified 2 warning signs for Coles Group that you should be aware of.

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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.