These 4 Measures Indicate That COLTENE Holding (VTX:CLTN) Is Using Debt Safely

Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital. When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. Importantly, COLTENE Holding AG (VTX:CLTN) does carry debt. But the real question is whether this debt is making the company risky.

When Is Debt Dangerous?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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. Of course, plenty of companies use debt to fund growth, without any negative consequences. The first step when considering a company's debt levels is to consider its cash and debt together.

Check out our latest analysis for COLTENE Holding

How Much Debt Does COLTENE Holding Carry?

As you can see below, at the end of December 2019, COLTENE Holding had CHF59.2m of debt, up from CHF49.1m a year ago. Click the image for more detail. However, it does have CHF23.4m in cash offsetting this, leading to net debt of about CHF35.7m.

A Look At COLTENE Holding's Liabilities

Zooming in on the latest balance sheet data, we can see that COLTENE Holding had liabilities of CHF93.2m due within 12 months and liabilities of CHF5.44m due beyond that. On the other hand, it had cash of CHF23.4m and CHF53.0m worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by CHF22.2m.

Given COLTENE Holding has a market capitalization of CHF460.1m, it's hard to believe these liabilities pose much threat. But there are sufficient liabilities that we would certainly recommend shareholders continue to monitor the balance sheet, going forward.

We measure a company's debt load relative to its earnings power by looking at its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and by calculating how easily its earnings before interest and tax (EBIT) cover its interest expense (interest cover). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

COLTENE Holding has a low net debt to EBITDA ratio of only 0.95. And its EBIT covers its interest expense a whopping 42.7 times over. So you could argue it is no more threatened by its debt than an elephant is by a mouse. Also positive, COLTENE Holding grew its EBIT by 26% in the last year, and that should make it easier to pay down debt, going forward. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine COLTENE Holding'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.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. So the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. Looking at the most recent three years, COLTENE Holding recorded free cash flow of 48% of its EBIT, which is weaker than we'd expect. That's not great, when it comes to paying down debt.

Our View

The good news is that COLTENE Holding's demonstrated ability to cover its interest expense with its EBIT delights us like a fluffy puppy does a toddler. And the good news does not stop there, as its EBIT growth rate also supports that impression! It's also worth noting that COLTENE Holding is in the Medical Equipment industry, which is often considered to be quite defensive. Zooming out, COLTENE Holding seems to use debt quite reasonably; and that gets the nod from us. After all, sensible leverage can boost returns on equity. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. Consider risks, for instance. Every company has them, and we've spotted 2 warning signs for COLTENE Holding you should know about.

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

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This article by Simply Wall St is general in nature. 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. Thank you for reading.