Is Ecolab (NYSE:ECL) A Risky Investment?

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 note that Ecolab Inc. (NYSE:ECL) does have debt on its balance sheet. But should shareholders be worried about its use of debt?

What Risk Does Debt Bring?

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 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, 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 examine debt levels, we first consider both cash and debt levels, together.

Check out our latest analysis for Ecolab

How Much Debt Does Ecolab Carry?

The chart below, which you can click on for greater detail, shows that Ecolab had US$8.60b in debt in September 2023; about the same as the year before. On the flip side, it has US$1.00b in cash leading to net debt of about US$7.60b.

How Strong Is Ecolab's Balance Sheet?

According to the last reported balance sheet, Ecolab had liabilities of US$4.60b due within 12 months, and liabilities of US$9.44b due beyond 12 months. Offsetting these obligations, it had cash of US$1.00b as well as receivables valued at US$3.02b due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by US$10.0b.

Of course, Ecolab has a titanic market capitalization of US$56.8b, so these liabilities are probably manageable. Having said that, it's clear that we should continue to monitor its balance sheet, lest it change for the worse.

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). 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).

Ecolab's debt is 2.5 times its EBITDA, and its EBIT cover its interest expense 7.0 times over. Taken together this implies that, while we wouldn't want to see debt levels rise, we think it can handle its current leverage. If Ecolab can keep growing EBIT at last year's rate of 14% over the last year, then it will find its debt load easier to manage. 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 Ecolab'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 clearly need to look at whether that EBIT is leading to corresponding free cash flow. Over the most recent three years, Ecolab recorded free cash flow worth 71% 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, Ecolab's impressive conversion of EBIT to free cash flow implies it has the upper hand on its debt. But truth be told we feel its net debt to EBITDA does undermine this impression a bit. Taking all this data into account, it seems to us that Ecolab takes a pretty sensible approach to debt. While that brings some risk, it can also enhance returns for shareholders. 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. To that end, you should be aware of the 2 warning signs we've spotted with Ecolab .

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.