Is Comet Holding (VTX:COTN) Using Too Much Debt?

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.' So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. As with many other companies Comet Holding AG (VTX:COTN) makes use of debt. But should shareholders be worried about its use of debt?

Why Does Debt Bring Risk?

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 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 think about a company's use of debt, we first look at cash and debt together.

Check out our latest analysis for Comet Holding

What Is Comet Holding's Net Debt?

You can click the graphic below for the historical numbers, but it shows that Comet Holding had CHF59.5m of debt in June 2021, down from CHF67.9m, one year before. But on the other hand it also has CHF76.4m in cash, leading to a CHF16.8m net cash position.

How Strong Is Comet Holding's Balance Sheet?

According to the last reported balance sheet, Comet Holding had liabilities of CHF120.0m due within 12 months, and liabilities of CHF93.2m due beyond 12 months. Offsetting this, it had CHF76.4m in cash and CHF77.2m in receivables that were due within 12 months. So it has liabilities totalling CHF59.7m more than its cash and near-term receivables, combined.

Given Comet Holding has a market capitalization of CHF2.45b, it's hard to believe these liabilities pose much threat. Having said that, it's clear that we should continue to monitor its balance sheet, lest it change for the worse. While it does have liabilities worth noting, Comet Holding also has more cash than debt, so we're pretty confident it can manage its debt safely.

Even more impressive was the fact that Comet Holding grew its EBIT by 102% over twelve months. That boost will make it even easier to pay down debt going forward. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Comet Holding 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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. Comet Holding 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. During the last three years, Comet Holding generated free cash flow amounting to a very robust 82% of its EBIT, more than we'd expect. That puts it in a very strong position to pay down debt.

Summing up

We could understand if investors are concerned about Comet Holding's liabilities, but we can be reassured by the fact it has has net cash of CHF16.8m. And it impressed us with free cash flow of CHF55m, being 82% of its EBIT. So is Comet Holding's debt a risk? It doesn't seem so to us. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. We've identified 1 warning sign with Comet Holding , and understanding them should be part of your investment process.

At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.

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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.
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