We Think PZ Cussons (LON:PZC) Can Stay On Top Of Its 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.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. As with many other companies PZ Cussons Plc (LON:PZC) makes use of debt. But the real question is whether this debt is making the company risky.

What Risk Does Debt Bring?

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we examine debt levels, we first consider both cash and debt levels, together.

Check out our latest analysis for PZ Cussons

How Much Debt Does PZ Cussons Carry?

As you can see below, PZ Cussons had UK£108.0m of debt at November 2020, down from UK£178.0m a year prior. However, it does have UK£89.8m in cash offsetting this, leading to net debt of about UK£18.2m.

How Healthy Is PZ Cussons' Balance Sheet?

The latest balance sheet data shows that PZ Cussons had liabilities of UK£211.9m due within a year, and liabilities of UK£195.9m falling due after that. Offsetting these obligations, it had cash of UK£89.8m as well as receivables valued at UK£120.9m due within 12 months. So its liabilities total UK£197.1m more than the combination of its cash and short-term receivables.

Given PZ Cussons has a market capitalization of UK£1.13b, it's hard to believe these liabilities pose much 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). 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).

PZ Cussons's net debt is only 0.20 times its EBITDA. And its EBIT easily covers its interest expense, being 26.6 times the size. So you could argue it is no more threatened by its debt than an elephant is by a mouse. But the bad news is that PZ Cussons has seen its EBIT plunge 14% in the last twelve months. We think hat kind of performance, if repeated frequently, could well lead to difficulties for the stock. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine PZ Cussons'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 it's worth checking how much of that EBIT is backed by free cash flow. Over the last three years, PZ Cussons recorded free cash flow worth a fulsome 92% of its EBIT, which is stronger than we'd usually expect. That puts it in a very strong position to pay down debt.

Our View

The good news is that PZ Cussons's demonstrated ability to cover its interest expense with its EBIT delights us like a fluffy puppy does a toddler. But the stark truth is that we are concerned by its EBIT growth rate. Taking all this data into account, it seems to us that PZ Cussons takes a pretty sensible approach to debt. While that brings some risk, it can also enhance returns for shareholders. 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 3 warning signs for PZ Cussons that you should be aware of before investing here.

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. 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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