Costco Wholesale (NASDAQ:COST) Seems To Use Debt Quite Sensibly

Warren Buffett famously said, 'Volatility is far from synonymous with risk.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. We can see that Costco Wholesale Corporation (NASDAQ:COST) does use debt in its business. But the more important question is: how much risk is that debt creating?

When Is Debt Dangerous?

Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. 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 think about a company's use of debt, we first look at cash and debt together.

See our latest analysis for Costco Wholesale

What Is Costco Wholesale's Debt?

The chart below, which you can click on for greater detail, shows that Costco Wholesale had US$6.58b in debt in February 2023; about the same as the year before. However, it does have US$13.7b in cash offsetting this, leading to net cash of US$7.12b.

How Healthy Is Costco Wholesale's Balance Sheet?

The latest balance sheet data shows that Costco Wholesale had liabilities of US$32.5b due within a year, and liabilities of US$11.5b falling due after that. Offsetting these obligations, it had cash of US$13.7b as well as receivables valued at US$2.71b due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by US$27.6b.

Given Costco Wholesale has a humongous market capitalization of US$220.2b, 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. Despite its noteworthy liabilities, Costco Wholesale boasts net cash, so it's fair to say it does not have a heavy debt load!

Costco Wholesale'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. 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 Costco Wholesale can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. Costco Wholesale may have net cash on the balance sheet, but it is still interesting to look at how well the business converts its earnings before interest and tax (EBIT) to free cash flow, because that will influence both its need for, and its capacity to manage debt. During the last three years, Costco Wholesale produced sturdy free cash flow equating to 80% of its EBIT, about what we'd expect. This cold hard cash means it can reduce its debt when it wants to.

Summing Up

While Costco Wholesale does have more liabilities than liquid assets, it also has net cash of US$7.12b. The cherry on top was that in converted 80% of that EBIT to free cash flow, bringing in US$5.5b. So we don't think Costco Wholesale's use of debt is risky. 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. Case in point: We've spotted 1 warning sign for Costco Wholesale you should be aware of.

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. 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.