Legendary fund manager Li Lu (whom Charlie Munger once backed) once said, “The biggest risk in investing is not price volatility, but whether you will suffer a permanent loss of capital. So it may be obvious that you need to take debt into account when thinking about the risk of a given stock, because too much debt can sink a business. Like many other companies Croda International Plc (LON: CRDA) resorts to debt. But does this debt worry shareholders?
Why is debt risky?
Debt is a tool to help businesses grow, but if a business is unable to repay its lenders, it exists at their mercy. Ultimately, if the company cannot meet its legal debt repayment obligations, shareholders could walk away with nothing. Although not too common, we often see companies in debt permanently diluting their shareholders because lenders force them to raise capital at a ridiculous price. That said, the most common situation is when a company manages its debt reasonably well – and to its own benefit. The first thing to do when considering how much debt a business has is to look at its cash and debt together.
Discover our latest analysis for Croda International
What is Croda International’s net debt?
As you can see below, at the end of June 2022, Croda International had a debt of £1.03 billion, up from £888.3 million a year ago. Click on the image for more details. On the other hand, he has £786.4m in cash, resulting in a net debt of around £240.0m.
How healthy is Croda International’s balance sheet?
According to the latest published balance sheet, Croda International had liabilities of £560.4m due within 12 months and liabilities of £1.18bn due beyond 12 months. In return, he had £786.4 million in cash and £472.6 million in debt due within 12 months. Thus, its liabilities total £486.0 million more than the combination of its cash and short-term receivables.
Given that Croda International has a whopping market capitalization of £9.58 billion, it’s hard to believe that these liabilities pose a threat. However, we think it’s worth keeping an eye on the strength of its balance sheet, as it can change over time.
In order to assess a company’s debt relative to its earnings, we calculate its net debt divided by its earnings before interest, taxes, depreciation and amortization (EBITDA) and its earnings before interest and taxes (EBIT) divided by its expenses. interest (its interest coverage). Thus, we consider debt to earnings with and without amortization and depreciation expense.
Croda International’s net debt is only 0.42 times its EBITDA. And its EBIT covers its interest charges 22.2 times. One could therefore say that he is no more threatened by his debt than an elephant is by a mouse. In addition, Croda International has increased its EBIT by 35% over the last twelve months, and this growth will facilitate the management of its debt. The balance sheet is clearly the area to focus on when analyzing debt. But ultimately, the company’s future profitability will decide whether Croda International can strengthen its balance sheet over time. So if you want to see what the pros think, you might find this free analyst earnings forecast report Be interesting.
Finally, a company can only repay its debts with cold hard cash, not with book profits. We must therefore clearly examine whether this EBIT generates a corresponding free cash flow. Over the past three years, Croda International’s free cash flow has been 40% of its EBIT, less than we expected. This low cash conversion makes debt management more difficult.
Our point of view
Fortunately, Croda International’s impressive interest coverage means it has the upper hand on its debt. And the good news does not stop there, since its EBIT growth rate also confirms this impression! Overall, we think Croda International’s use of debt seems entirely reasonable and we are not concerned about that. Although debt carries risks, 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 reside on the balance sheet, far from it. For example, we have identified 2 warning signs for Croda International of which you should be aware.
If you are interested in investing in companies that can generate profits without the burden of debt, then check out this free list of growing companies that have net cash on the balance sheet.
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Find out if Croda International is potentially overvalued or undervalued by viewing our full analysis, which includes fair value estimates, risks and warnings, dividends, insider trading and financial health.
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This Simply Wall St article is general in nature. We provide commentary based on historical data and analyst forecasts only using unbiased methodology and our articles are not intended to be financial advice. It is not a recommendation to buy or sell stocks and does not take into account your objectives or financial situation. Our goal is to bring you targeted long-term analysis based on fundamental data. Note that our analysis may not take into account the latest announcements from price-sensitive companies or qualitative materials. Simply Wall St has no position in the stocks mentioned.
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