Coloplast (CPH: COLO B) seems to use debt quite wisely
Howard Marks put it well when he said that, rather than worrying about stock price volatility, “The possibility of permanent loss is the risk I worry about … and every investor practice that I know is worried “. So it can be obvious that you need to consider debt, when you think about how risky a given stock is because too much debt can sink a business. We can see that Coloplast A / S (CPH: COLO B) uses debt in his business. But the real question is whether this debt makes the business risky.
When is debt dangerous?
Debts and other liabilities become risky for a business when it cannot easily meet these obligations, either with free cash flow or by raising capital at an attractive price. In the worst case scenario, a business can go bankrupt if it cannot pay its creditors. However, a more common (but still costly) event is when a company has to issue stock at bargain prices, constantly diluting shareholders, just to strengthen its balance sheet. Of course, debt can be an important tool in businesses, especially capital intensive businesses. When we think of a business’s use of debt, we first look at cash flow and debt together.
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How much debt does Coloplast have?
As you can see below, at the end of March 2021, Coloplast was in debt of Kroner 3.50 billion, up from Kroner 2.62 billion a year ago. Click on the image for more details. However, it has 675.0 million crowns of cash offsetting this, which leads to net debt of around 2.83 billion crowns.
A look at the responsibilities of Coloplast
According to the latest published balance sheet, Coloplast had liabilities of SEK 6.82 billion due within 12 months and liabilities of SEK 1.49 billion due beyond 12 months. In return, he had 675.0 million kr in cash and 3.56 billion kr in receivables due within 12 months. Thus, its debts exceed the sum of its cash and its (short-term) receivables by 4.08 billion crowns.
This state of affairs indicates that Coloplast’s balance sheet looks quite strong, as the total of its liabilities roughly equals its cash. So while it’s hard to imagine kr.218.9ba struggling to raise money, we still think it’s worth watching its balance sheet. But in any case, Coloplast has virtually no net debt, so it’s fair to say that it doesn’t have a lot of debt!
In order to measure a company’s debt relative to its profits, we calculate its net debt divided by its earnings before interest, taxes, depreciation and amortization (EBITDA) and its profit before interest and taxes (EBIT) divided by its interest. debtors (its interest coverage). Thus, we look at debt over earnings with and without amortization charges.
Coloplast has a low net debt to EBITDA ratio of just 0.43. And its EBIT easily covers its interest costs, being 350 times higher. So we’re pretty relaxed about its ultra-conservative use of debt. Coloplast’s EBIT has been fairly stable over the past year, but that shouldn’t be a problem given that it doesn’t have a lot of debt. When analyzing debt levels, the balance sheet is the obvious starting point. But it is future profits, more than anything, that will determine Coloplast’s ability to maintain a healthy balance sheet in the future. So, if you want to see what the professionals think, you might find this free analyst earnings forecast report interesting.
Finally, while the IRS may love accounting profits, lenders only accept hard cash. We therefore always check how much of this EBIT is converted into free cash flow. Over the past three years, Coloplast has generated strong free cash flow equivalent to 61% of its EBIT, roughly what we expected. This hard cash allows him to reduce his debt whenever he wants.
Our point of view
Coloplast’s interest coverage suggests he can manage his debt as easily as Cristiano Ronaldo could score a goal against an Under-14 keeper. And the good news does not end there, since its net debt to EBITDA also confirms this impression! It should also be noted that Coloplast is part of the medical equipment industry, which is often seen as quite defensive. When you zoom out, Coloplast seems to be using the debt in a very reasonable way; and that gets the nod from us. While debt comes with risk, when used wisely, it can also generate a higher return on equity. There is no doubt that we learn the most about debt from the balance sheet. However, not all investment risks lie on the balance sheet – far from it. For example, we discovered 1 warning sign for Coloplast which you should know before investing here.
If, after all of this, you’re more interested in a fast-growing company with a strong balance sheet, take a quick look at our list of cash net growth stocks.
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