Coloplast (CPH:COLO B) Could Easily Take On More Debt

Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that '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. We can see that Coloplast A/S (CPH:COLO B) does use debt in its business. But the real question is whether this debt is making the company risky.

Why Does Debt Bring Risk?

Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. Of course, plenty of companies use debt to fund growth, without any negative consequences. When we examine debt levels, we first consider both cash and debt levels, together.

View our latest analysis for Coloplast

How Much Debt Does Coloplast Carry?

The image below, which you can click on for greater detail, shows that at September 2021 Coloplast had debt of kr.2.16b, up from kr.1.11b in one year. However, it does have kr.674.0m in cash offsetting this, leading to net debt of about kr.1.49b.

A Look At Coloplast's Liabilities

We can see from the most recent balance sheet that Coloplast had liabilities of kr.6.31b falling due within a year, and liabilities of kr.1.36b due beyond that. Offsetting these obligations, it had cash of kr.674.0m as well as receivables valued at kr.3.72b due within 12 months. So it has liabilities totalling kr.3.28b more than its cash and near-term receivables, combined.

This state of affairs indicates that Coloplast's balance sheet looks quite solid, as its total liabilities are just about equal to its liquid assets. So it's very unlikely that the kr.220.2b company is short on cash, but still worth keeping an eye on the balance sheet. Carrying virtually no net debt, Coloplast has a very light debt load indeed.

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). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

Coloplast has a low net debt to EBITDA ratio of only 0.22. And its EBIT easily covers its interest expense, being 453 times the size. So you could argue it is no more threatened by its debt than an elephant is by a mouse. The good news is that Coloplast has increased its EBIT by 8.4% over twelve months, which should ease any concerns about debt repayment. There's no doubt that we learn most about debt from the balance sheet. But it is future earnings, more than anything, that will determine Coloplast'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 it's worth checking how much of that EBIT is backed by free cash flow. During the last three years, Coloplast produced sturdy free cash flow equating to 61% of its EBIT, about what we'd expect. This cold hard cash means it can reduce its debt when it wants to.

Our View

Happily, Coloplast's impressive interest cover implies it has the upper hand on its debt. And the good news does not stop there, as its net debt to EBITDA also supports that impression! It's also worth noting that Coloplast is in the Medical Equipment industry, which is often considered to be quite defensive. Zooming out, Coloplast seems to use debt quite reasonably; and that gets the nod from us. After all, sensible leverage can boost returns on equity. Over time, share prices tend to follow earnings per share, so if you're interested in Coloplast, 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.

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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.