Coloplast (CPH:COLO B) Seems To Use Debt Quite Sensibly

Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' 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. 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.

When Is Debt Dangerous?

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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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. When we think about a company's use of debt, we first look at cash and debt together.

See our latest analysis for Coloplast

How Much Debt Does Coloplast Carry?

As you can see below, at the end of March 2021, Coloplast had kr.3.50b of debt, up from kr.2.62b a year ago. Click the image for more detail. However, it does have kr.675.0m in cash offsetting this, leading to net debt of about kr.2.83b.

A Look At Coloplast's Liabilities

According to the last reported balance sheet, Coloplast had liabilities of kr.6.82b due within 12 months, and liabilities of kr.1.49b due beyond 12 months. Offsetting this, it had kr.675.0m in cash and kr.3.56b in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by kr.4.08b.

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 while it's hard to imagine that the kr.218.9b company is struggling for cash, we still think it's worth monitoring its balance sheet. But either way, Coloplast has virtually no net debt, so it's fair to say it does not have a heavy debt load!

In order to size up a company's debt relative to its earnings, we calculate its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and its earnings before interest and tax (EBIT) divided by its interest expense (its interest cover). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

Coloplast has a low net debt to EBITDA ratio of only 0.43. And its EBIT easily covers its interest expense, being 350 times the size. So we're pretty relaxed about its super-conservative use of debt. Coloplast's EBIT was pretty flat over the last year, but that shouldn't be an issue given the it doesn't have a lot of debt. When analysing debt levels, the balance sheet is the obvious place to start. 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 want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So we always check how much of that EBIT is translated into 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

Coloplast's interest cover suggests it can handle its debt as easily as Cristiano Ronaldo could score a goal against an under 14's goalkeeper. 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. While debt does bring risk, when used wisely it can also bring a higher return on equity. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. For example, we've discovered 1 warning sign for Coloplast that you should be aware of before investing here.

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

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