David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the permanent loss of capital.' 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. We can see that The Cooper Companies, Inc. (NYSE:COO) does use debt in its business. But the real question is whether this debt is making the company risky.
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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.
What Is Cooper Companies's Net Debt?
The image below, which you can click on for greater detail, shows that at July 2020 Cooper Companies had debt of US$1.90b, up from US$1.81b in one year. On the flip side, it has US$127.4m in cash leading to net debt of about US$1.78b.
A Look At Cooper Companies's Liabilities
Zooming in on the latest balance sheet data, we can see that Cooper Companies had liabilities of US$1.13b due within 12 months and liabilities of US$1.86b due beyond that. Offsetting this, it had US$127.4m in cash and US$450.5m in receivables that were due within 12 months. So it has liabilities totalling US$2.41b more than its cash and near-term receivables, combined.
Of course, Cooper Companies has a titanic market capitalization of US$17.5b, so these liabilities are probably manageable. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time.
We use two main ratios to inform us about debt levels relative to earnings. The first is net debt divided by earnings before interest, tax, depreciation, and amortization (EBITDA), while the second is how many times its earnings before interest and tax (EBIT) covers its interest expense (or its interest cover, for short). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.
With net debt to EBITDA of 2.5 Cooper Companies has a fairly noticeable amount of debt. On the plus side, its EBIT was 9.3 times its interest expense, and its net debt to EBITDA, was quite high, at 2.5. Importantly, Cooper Companies's EBIT fell a jaw-dropping 21% in the last twelve months. If that earnings trend continues then paying off its debt will be about as easy as herding cats on to a roller coaster. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Cooper Companies 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 business needs free cash flow to pay off debt; accounting profits just don't cut it. So we always check how much of that EBIT is translated into free cash flow. In the last three years, Cooper Companies basically broke even on a free cash flow basis. Some might say that's a concern, when it comes considering how easily it would be for it to down debt.
Cooper Companies's EBIT growth rate was a real negative on this analysis, although the other factors we considered cast it in a significantly better light. For example its interest cover was refreshing. We should also note that Medical Equipment industry companies like Cooper Companies commonly do use debt without problems. When we consider all the factors discussed, it seems to us that Cooper Companies is taking some risks with its use of debt. So while that leverage does boost returns on equity, we wouldn't really want to see it increase from here. 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. To that end, you should be aware of the 3 warning signs we've spotted with Cooper Companies .
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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