Is Clorox (NYSE:CLX) A Risky Investment?

The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says 'The biggest investment risk is not the volatility of prices, but whether you will suffer a 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 Clorox Company (NYSE:CLX) does use debt in its business. But the real question is whether this debt is making the company risky.

When Is Debt A Problem?

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. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. Of course, plenty of companies use debt to fund growth, without any negative consequences. When we think about a company's use of debt, we first look at cash and debt together.

View our latest analysis for Clorox

How Much Debt Does Clorox Carry?

As you can see below, Clorox had US$2.59b of debt, at March 2024, which is about the same as the year before. You can click the chart for greater detail. However, it does have US$219.0m in cash offsetting this, leading to net debt of about US$2.37b.

How Healthy Is Clorox's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Clorox had liabilities of US$1.85b due within 12 months and liabilities of US$3.70b due beyond that. Offsetting these obligations, it had cash of US$219.0m as well as receivables valued at US$673.0m due within 12 months. So it has liabilities totalling US$4.66b more than its cash and near-term receivables, combined.

While this might seem like a lot, it is not so bad since Clorox has a huge market capitalization of US$16.3b, and so it could probably strengthen its balance sheet by raising capital if it needed to. But we definitely want to keep our eyes open to indications that its debt is bringing too much risk.

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). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

Clorox's net debt to EBITDA ratio of about 2.1 suggests only moderate use of debt. And its commanding EBIT of 14.8 times its interest expense, implies the debt load is as light as a peacock feather. Also relevant is that Clorox has grown its EBIT by a very respectable 27% in the last year, thus enhancing its ability to pay down debt. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Clorox'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, a company can only pay off debt with cold hard cash, not accounting profits. So the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. Over the last three years, Clorox recorded free cash flow worth a fulsome 86% 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

Happily, Clorox's impressive interest cover implies it has the upper hand on its debt. And the good news does not stop there, as its conversion of EBIT to free cash flow also supports that impression! Looking at the bigger picture, we think Clorox's use of debt seems quite reasonable and we're not concerned about it. After all, sensible leverage can boost returns on equity. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. We've identified 3 warning signs with Clorox (at least 1 which shouldn't be ignored) , and understanding them should be part of your investment process.

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.