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

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. Importantly, Cochlear Limited (ASX:COH) does carry debt. But is this debt a concern to shareholders?

When Is Debt A Problem?

Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. 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 Net Debt?

You can click the graphic below for the historical numbers, but it shows that Cochlear had AU$41.3m of debt in December 2022, down from AU$47.5m, one year before. However, it does have AU$546.7m in cash offsetting this, leading to net cash of AU$505.4m.

How Strong Is Cochlear's Balance Sheet?

According to the last reported balance sheet, Cochlear had liabilities of AU$464.2m due within 12 months, and liabilities of AU$287.2m due beyond 12 months. Offsetting these obligations, it had cash of AU$546.7m as well as receivables valued at AU$432.6m due within 12 months. So it actually has AU$227.9m 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$15.9b 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 the other hand, Cochlear saw its EBIT drop by 4.9% in the last twelve months. That sort of decline, if sustained, will obviously make debt harder to handle. The balance sheet is clearly the area to focus on when you are analysing debt. 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're focused on the future you can check out this free report showing analyst profit forecasts.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. Cochlear may have net cash on the balance sheet, but it is still interesting to look at how well the business converts its earnings before interest and tax (EBIT) to free cash flow, because that will influence both its need for, and its capacity to manage debt. Over the last three years, Cochlear reported free cash flow worth 20% of its EBIT, which is really quite low. For us, cash conversion that low sparks a little paranoia about is ability to extinguish debt.

Summing Up

While it is always sensible to investigate a company's debt, in this case Cochlear has AU$505.4m in net cash and a decent-looking balance sheet. So we are not troubled with Cochlear's debt use. Above most other metrics, we think its important to track how fast earnings per share is growing, if at all. If you've also come to that realization, you're in luck, because today you can view this interactive graph of Cochlear's earnings per share history for free.

If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.

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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.