Here’s why ConvaTec Group (LON:CTEC) can manage its debt responsibly

Howard Marks said 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 that every practical investor that I know is worried”. It’s natural to consider a company’s balance sheet when looking at its riskiness, as debt is often involved when a company fails. We can see that ConvaTec Group Plc (LON:CTEC) uses debt in its business. But the real question is whether this debt makes the business risky.

When is debt dangerous?

Generally speaking, debt only becomes a real problem when a company cannot easily repay it, either by raising capital or with its own cash flow. If things go really bad, lenders can take over the business. 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. Of course, many companies use debt to finance their growth, without any negative consequences. The first thing to do when considering how much debt a business has is to look at its cash and debt together.

See our latest analysis for ConvaTec Group

How much debt does the ConvaTec group carry?

As you can see below, the ConvaTec Group had a debt of US$1.35 billion in December 2021, compared to US$1.46 billion the previous year. On the other hand, he has $463.4 million in cash, resulting in a net debt of around $884.1 million.

LSE: history of CTEC’s debt to equity June 22, 2022

How strong is the ConvaTec Group’s balance sheet?

According to the latest published balance sheet, the ConvaTec Group had liabilities of US$569.2 million due within 12 months and liabilities of US$1.41 billion due beyond 12 months. In return, he had $463.4 million in cash and $301.5 million in receivables due within 12 months. Thus, its liabilities total $1.21 billion more than the combination of its cash and short-term receivables.

While that might sound like a lot, it’s not that bad since ConvaTec Group has a market capitalization of US$5.36 billion, so it could probably bolster its balance sheet by raising capital if needed. But it is clear that it must be carefully examined whether he can manage his debt without dilution.

We measure a company’s leverage against its earning power by looking at its net debt divided by its earnings before interest, taxes, depreciation and amortization (EBITDA) and calculating how easily its earnings before interest and taxes (EBIT ) covers its interest charge (interest coverage). In this way, we consider both the absolute amount of debt, as well as the interest rates paid on it.

The ConvaTec Group has net debt worth 2.2x EBITDA, which isn’t too much, but its interest coverage looks a little low, with EBIT at just 6.5x operating expenses. ‘interests. While these numbers don’t alarm us, it’s worth noting that the company’s cost of debt has a real impact. We have seen the ConvaTec Group increase its EBIT by 2.8% over the last twelve months. While that barely brings us down, it’s a positive when it comes to debt. There is no doubt that we learn the most about debt from the balance sheet. But ultimately, the future profitability of the business will decide whether the ConvaTec Group can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free analyst earnings forecast report interesting.

But our last consideration is also important, because a company cannot pay debt with paper profits; he needs cash. So the logical step is to look at what proportion of that EBIT is actual free cash flow. Fortunately for all shareholders, the ConvaTec Group has actually produced more free cash flow than EBIT over the past three years. There’s nothing better than cash coming in to stay in your lenders’ good books.

Our point of view

The good news is that the ConvaTec Group’s demonstrated ability to convert EBIT into free cash flow delights us like a fluffy puppy does a toddler. And we also thought its interest coverage was a positive. We also note that companies in the medical equipment industry like ConvaTec Group generally use debt without issue. When we consider the range of factors above, it seems that the ConvaTec Group is quite sensitive with its use of debt. While this carries some risk, it can also improve shareholder returns. The balance sheet is clearly the area to focus on when analyzing debt. But at the end of the day, every business can contain risks that exist outside of the balance sheet. For example – ConvaTec Group has 2 warning signs we think you should know.

If, after all that, you’re more interested in a fast-growing company with a strong balance sheet, check out our list of cash-neutral growth stocks right away.

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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