Coloplast (CPH:COLO B) Seems To Use Debt Rather Sparingly

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. As with many other companies Coloplast A/S (CPH:COLO B) makes use of debt. But should shareholders be worried about its use of debt?

What Risk Does Debt Bring?

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. 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?

You can click the graphic below for the historical numbers, but it shows that as of December 2021 Coloplast had kr.4.44b of debt, an increase on kr.4.02b, over one year. However, because it has a cash reserve of kr.864.0m, its net debt is less, at about kr.3.57b.

How Strong Is Coloplast's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Coloplast had liabilities of kr.8.48b due within 12 months and liabilities of kr.1.29b due beyond that. Offsetting these obligations, it had cash of kr.864.0m as well as receivables valued at kr.3.74b due within 12 months. So its liabilities total kr.5.16b more than the combination of its cash and short-term receivables.

Given Coloplast has a humongous market capitalization of kr.227.9b, 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.

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). The advantage of this approach is that we take into account both the absolute quantum of debt (with net debt to EBITDA) and the actual interest expenses associated with that debt (with its interest cover ratio).

Coloplast has a low net debt to EBITDA ratio of only 0.51. And its EBIT covers its interest expense a whopping 496 times over. 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 9.0% over twelve months, which should ease any concerns about debt repayment. When analysing debt levels, the balance sheet is the obvious place to start. 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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. Over the most recent three years, Coloplast recorded free cash flow worth 61% of its EBIT, which is around normal, given free cash flow excludes interest and tax. 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. 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. Be aware that Coloplast is showing 2 warning signs in our investment analysis , 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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

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.