Cochlear (ASX:COH) Seems To Use Debt Quite Sensibly

David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the 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. We note that Cochlear Limited (ASX:COH) does have debt on its balance sheet. But the real question is whether this debt is making the company risky.

When Is Debt Dangerous?

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. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we examine debt levels, we first consider both cash and debt levels, together.

View our latest analysis for Cochlear

What Is Cochlear's Debt?

The image below, which you can click on for greater detail, shows that Cochlear had debt of AU$45.0m at the end of June 2021, a reduction from AU$473.0m over a year. But on the other hand it also has AU$609.6m in cash, leading to a AU$564.6m net cash position.

How Strong Is Cochlear's Balance Sheet?

The latest balance sheet data shows that Cochlear had liabilities of AU$402.5m due within a year, and liabilities of AU$334.0m falling due after that. Offsetting this, it had AU$609.6m in cash and AU$365.5m in receivables that were due within 12 months. So it actually has AU$238.6m more liquid assets than total liabilities.

Having regard to Cochlear's size, it seems that its liquid assets are well balanced with its total liabilities. So while it's hard to imagine that the AU$14.5b company is struggling for cash, we still think it's worth monitoring its balance sheet. Succinctly put, Cochlear boasts net cash, so it's fair to say it does not have a heavy debt load!

On top of that, Cochlear grew its EBIT by 57% over the last twelve months, and that growth will make it easier to handle its debt. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Cochlear's ability to maintain a healthy balance sheet going forward. 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. While Cochlear has net cash on its balance sheet, it's still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. Over the last three years, Cochlear reported free cash flow worth 10.0% of its EBIT, which is really quite low. That limp level of cash conversion undermines its ability to manage and pay down debt.

Summing up

While we empathize with investors who find debt concerning, you should keep in mind that Cochlear has net cash of AU$564.6m, as well as more liquid assets than liabilities. And we liked the look of last year's 57% year-on-year EBIT growth. So we don't think Cochlear's use of debt is risky. Over time, share prices tend to follow earnings per share, so if you're interested in Cochlear, you may well want to click here to check an interactive graph of its earnings per share history.

When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.

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.

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