CCL Industries (TSE:CCL.B) Seems To Use Debt Quite Sensibly

The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' 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 CCL Industries Inc. (TSE:CCL.B) makes use of 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. 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, debt can be an important tool in businesses, particularly capital heavy businesses. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

See our latest analysis for CCL Industries

What Is CCL Industries's Debt?

As you can see below, CCL Industries had CA$1.72b of debt at September 2021, down from CA$2.31b a year prior. However, because it has a cash reserve of CA$622.5m, its net debt is less, at about CA$1.10b.

How Strong Is CCL Industries' Balance Sheet?

Zooming in on the latest balance sheet data, we can see that CCL Industries had liabilities of CA$1.41b due within 12 months and liabilities of CA$2.48b due beyond that. Offsetting this, it had CA$622.5m in cash and CA$1.15b in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by CA$2.12b.

Since publicly traded CCL Industries shares are worth a total of CA$11.6b, it seems unlikely that this level of liabilities would be a major threat. Having said that, it's clear that we should continue to monitor its balance sheet, lest it change for the worse.

We use two main ratios to inform us about debt levels relative to earnings. The first is net debt divided by earnings before interest, tax, depreciation, and amortization (EBITDA), while the second is how many times its earnings before interest and tax (EBIT) covers its interest expense (or its interest cover, for short). 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).

CCL Industries's net debt is only 0.97 times its EBITDA. And its EBIT easily covers its interest expense, being 13.1 times the size. So we're pretty relaxed about its super-conservative use of debt. And we also note warmly that CCL Industries grew its EBIT by 12% last year, making its debt load easier to handle. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately the future profitability of the business will decide if CCL Industries 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, a company can only pay off debt with cold hard cash, not accounting profits. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. Over the most recent three years, CCL Industries recorded free cash flow worth 70% 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

Happily, CCL Industries's impressive interest cover implies it has the upper hand on its debt. And that's just the beginning of the good news since its conversion of EBIT to free cash flow is also very heartening. Zooming out, CCL Industries seems to use debt quite reasonably; and that gets the nod from us. After all, sensible leverage can boost returns on equity. Of course, we wouldn't say no to the extra confidence that we'd gain if we knew that CCL Industries insiders have been buying shares: if you're on the same wavelength, you can find out if insiders are buying by clicking this link.

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.