Kenvue (NYSE:KVUE) Seems To Use Debt Quite Sensibly

Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that '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 Kenvue Inc. (NYSE:KVUE) does use debt in its business. But the real question is whether this debt is making the company risky.

When Is Debt Dangerous?

Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. 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.

Check out our latest analysis for Kenvue

What Is Kenvue's Net Debt?

As you can see below, at the end of September 2024, Kenvue had US$8.59b of debt, up from US$8.20b a year ago. Click the image for more detail. However, it also had US$1.06b in cash, and so its net debt is US$7.53b.

How Healthy Is Kenvue's Balance Sheet?

The latest balance sheet data shows that Kenvue had liabilities of US$5.95b due within a year, and liabilities of US$10.3b falling due after that. Offsetting this, it had US$1.06b in cash and US$2.39b in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by US$12.8b.

While this might seem like a lot, it is not so bad since Kenvue has a huge market capitalization of US$43.8b, 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). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

Kenvue's net debt of 2.1 times EBITDA suggests graceful use of debt. And the fact that its trailing twelve months of EBIT was 7.7 times its interest expenses harmonizes with that theme. Kenvue grew its EBIT by 2.7% in the last year. Whilst that hardly knocks our socks off it is a positive when it comes to debt. 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 Kenvue'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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So we always check how much of that EBIT is translated into free cash flow. Over the most recent three years, Kenvue recorded free cash flow worth 75% 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, Kenvue's impressive conversion of EBIT to free cash flow implies it has the upper hand on its debt. And we also thought its interest cover was a positive. Looking at all the aforementioned factors together, it strikes us that Kenvue can handle its debt fairly comfortably. 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. 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. To that end, you should learn about the 4 warning signs we've spotted with Kenvue (including 1 which is a bit unpleasant) .

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.