Is Colgate-Palmolive (NYSE:CL) A Risky Investment?

Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' So it seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. We note that Colgate-Palmolive Company (NYSE:CL) does have debt on its balance sheet. But is this debt a concern to shareholders?

What Risk Does Debt Bring?

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. If things get really bad, the lenders can take control of the business. 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. Of course, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. When we think about a company's use of debt, we first look at cash and debt together.

View our latest analysis for Colgate-Palmolive

How Much Debt Does Colgate-Palmolive Carry?

The image below, which you can click on for greater detail, shows that at September 2023 Colgate-Palmolive had debt of US$8.72b, up from US$8.25b in one year. However, it does have US$1.20b in cash offsetting this, leading to net debt of about US$7.53b.

How Healthy Is Colgate-Palmolive's Balance Sheet?

We can see from the most recent balance sheet that Colgate-Palmolive had liabilities of US$4.60b falling due within a year, and liabilities of US$11.0b due beyond that. Offsetting this, it had US$1.20b in cash and US$1.58b in receivables that were due within 12 months. So it has liabilities totalling US$12.9b more than its cash and near-term receivables, combined.

Of course, Colgate-Palmolive has a titanic market capitalization of US$66.6b, so these liabilities are probably manageable. But there are sufficient liabilities that we would certainly recommend shareholders continue to monitor the balance sheet, going forward.

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).

We'd say that Colgate-Palmolive's moderate net debt to EBITDA ratio ( being 1.8), indicates prudence when it comes to debt. And its commanding EBIT of 15.6 times its interest expense, implies the debt load is as light as a peacock feather. Unfortunately, Colgate-Palmolive saw its EBIT slide 2.1% in the last twelve months. If that earnings trend continues then its debt load will grow heavy like the heart of a polar bear watching its sole cub. 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 Colgate-Palmolive 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, Colgate-Palmolive recorded free cash flow worth 69% 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, Colgate-Palmolive's impressive interest cover implies it has the upper hand on its debt. But truth be told we feel its EBIT growth rate does undermine this impression a bit. All these things considered, it appears that Colgate-Palmolive can comfortably handle its current debt levels. Of course, while this leverage can enhance returns on equity, it does bring more risk, so it's worth keeping an eye on this one. 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. These risks can be hard to spot. Every company has them, and we've spotted 3 warning signs for Colgate-Palmolive 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.

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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.