Here's Why Croda International (LON:CRDA) Can Manage Its Debt Responsibly

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.' 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 Croda International Plc (LON:CRDA) makes use of debt. But is this debt a concern to shareholders?

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What Risk Does Debt Bring?

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 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.

What Is Croda International's Net Debt?

As you can see below, Croda International had UK£615.2m of debt, at December 2024, which is about the same as the year before. You can click the chart for greater detail. On the flip side, it has UK£166.8m in cash leading to net debt of about UK£448.4m.

How Healthy Is Croda International's Balance Sheet?

We can see from the most recent balance sheet that Croda International had liabilities of UK£336.5m falling due within a year, and liabilities of UK£875.9m due beyond that. Offsetting this, it had UK£166.8m in cash and UK£334.4m in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by UK£711.2m.

Given Croda International has a market capitalization of UK£4.28b, it's hard to believe these liabilities pose much threat. But there are sufficient liabilities that we would certainly recommend shareholders continue to monitor the balance sheet, going forward.

View our latest analysis for Croda International

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).

Croda International has net debt of just 1.3 times EBITDA, indicating that it is certainly not a reckless borrower. And this view is supported by the solid interest coverage, with EBIT coming in at 9.6 times the interest expense over the last year. On the other hand, Croda International saw its EBIT drop by 8.3% in the last twelve months. That sort of decline, if sustained, will obviously make debt harder to handle. 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 Croda International'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 company can only pay off debt with cold hard cash, not accounting profits. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. In the last three years, Croda International's free cash flow amounted to 47% of its EBIT, less than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.

Our View

When it comes to the balance sheet, the standout positive for Croda International was the fact that it seems able to cover its interest expense with its EBIT confidently. But the other factors we noted above weren't so encouraging. For example, its EBIT growth rate makes us a little nervous about its debt. Looking at all this data makes us feel a little cautious about Croda International's debt levels. While we appreciate debt can enhance returns on equity, we'd suggest that shareholders keep close watch on its debt levels, lest they increase. 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 - Croda International has 1 warning sign we think you should be aware of.

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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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.