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

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 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 note that Coloplast A/S (CPH:COLO B) does have debt on its balance sheet. But is this debt a concern to shareholders?

Why Does Debt Bring Risk?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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 think about a company's use of debt, we first look at cash and debt together.

See our latest analysis for Coloplast

What Is Coloplast's Debt?

The image below, which you can click on for greater detail, shows that at June 2024 Coloplast had debt of kr.23.5b, up from kr.21.2b in one year. However, it also had kr.887.0m in cash, and so its net debt is kr.22.6b.

How Healthy Is Coloplast's Balance Sheet?

According to the last reported balance sheet, Coloplast had liabilities of kr.12.5b due within 12 months, and liabilities of kr.19.6b due beyond 12 months. Offsetting this, it had kr.887.0m in cash and kr.5.72b in receivables that were due within 12 months. So it has liabilities totalling kr.25.4b more than its cash and near-term receivables, combined.

Since publicly traded Coloplast shares are worth a very impressive total of kr.199.5b, it seems unlikely that this level of liabilities would be a major threat. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time.

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

Coloplast has a debt to EBITDA ratio of 2.8, which signals significant debt, but is still pretty reasonable for most types of business. But its EBIT was about 11.3 times its interest expense, implying the company isn't really paying a high cost to maintain that level of debt. Even were the low cost to prove unsustainable, that is a good sign. Coloplast grew its EBIT by 3.3% in the last year. That's far from incredible but it is a good thing, when it comes to paying off debt. 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 Coloplast can strengthen its balance sheet over time. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. So we always check how much of that EBIT is translated into free cash flow. In the last three years, Coloplast's free cash flow amounted to 40% of its EBIT, less than we'd expect. That's not great, when it comes to paying down debt.

Our View

The good news is that Coloplast's demonstrated ability to cover its interest expense with its EBIT delights us like a fluffy puppy does a toddler. But, on a more sombre note, we are a little concerned by its net debt to EBITDA. We would also note that Medical Equipment industry companies like Coloplast commonly do use debt without problems. All these things considered, it appears that Coloplast can comfortably handle its current debt levels. On the plus side, this leverage can boost shareholder returns, but the potential downside is more risk of loss, so it's worth monitoring the balance sheet. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. Be aware that Coloplast is showing 2 warning signs in our investment analysis , you should know about...

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.