Is Cabot (NYSE:CBT) Using Too Much Debt?

Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' 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 Cabot Corporation (NYSE:CBT) does use debt in its business. But is this debt a concern to shareholders?

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

See our latest analysis for Cabot

What Is Cabot's Debt?

The image below, which you can click on for greater detail, shows that Cabot had debt of US$1.11b at the end of September 2024, a reduction from US$1.25b over a year. However, because it has a cash reserve of US$223.0m, its net debt is less, at about US$890.0m.

A Look At Cabot's Liabilities

We can see from the most recent balance sheet that Cabot had liabilities of US$772.0m falling due within a year, and liabilities of US$1.37b due beyond that. Offsetting these obligations, it had cash of US$223.0m as well as receivables valued at US$733.0m due within 12 months. So its liabilities total US$1.19b more than the combination of its cash and short-term receivables.

While this might seem like a lot, it is not so bad since Cabot has a market capitalization of US$4.86b, and so it could probably strengthen its balance sheet by raising capital if it needed to. However, it is still worthwhile taking a close look at its ability to pay off debt.

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). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

Cabot has a low net debt to EBITDA ratio of only 1.1. And its EBIT easily covers its interest expense, being 12.8 times the size. So we're pretty relaxed about its super-conservative use of debt. And we also note warmly that Cabot grew its EBIT by 20% last year, making its debt load easier to handle. 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 Cabot's ability to maintain a healthy balance sheet going forward. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. In the last three years, Cabot's free cash flow amounted to 40% of its EBIT, less than we'd expect. That's not great, when it comes to paying down debt.

Our View

Cabot's interest cover suggests it can handle its debt as easily as Cristiano Ronaldo could score a goal against an under 14's goalkeeper. And the good news does not stop there, as its EBIT growth rate also supports that impression! All these things considered, it appears that Cabot can comfortably handle its current debt levels. On the plus side, this leverage can boost shareholder returns, but the potential downside is more risk of loss, so it's worth monitoring the balance sheet. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. These risks can be hard to spot. Every company has them, and we've spotted 2 warning signs for Cabot you should know about.

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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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.