We think Church & Dwight (NYSE:CHD) can stay on top of debt
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”. When we think of a company’s risk, we always like to look at its use of debt, because over-indebtedness can lead to ruin. We note that Church & Dwight Co., Inc. (NYSE:CHD) has debt on its balance sheet. But the real question is whether this debt makes the business risky.
When is debt a problem?
Debt helps a business until the business struggles to pay it back, either with new capital or with free cash flow. An integral part of capitalism is the process of “creative destruction” where bankrupt companies are mercilessly liquidated by their bankers. However, a more usual (but still expensive) situation is when a company has to dilute shareholders at a cheap share price just to keep debt under control. That said, the most common situation is when a company manages its debt reasonably well – and to its own benefit. When we think about a company’s use of debt, we first look at cash and debt together.
What is Church & Dwight Debt?
You can click on the graph below for historical numbers, but it shows that in June 2022 Church & Dwight had $2.81 billion in debt, an increase of $1.95 billion, on a year. However, he also had $639.7 million in cash, so his net debt is $2.17 billion.
How strong is Church & Dwight’s balance sheet?
We can see from the most recent balance sheet that Church & Dwight had liabilities of $1.73 billion due in one year, and liabilities of $3.16 billion beyond. In return, he had $639.7 million in cash and $405.8 million in receivables due within 12 months. It therefore has liabilities totaling $3.84 billion more than its cash and short-term receivables, combined.
Of course, Church & Dwight has a titanic market capitalization of US$21.1 billion, so those liabilities are probably manageable. But there are enough liabilities that we certainly recommend that shareholders continue to monitor the balance sheet in the future.
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.
Church & Dwight’s net debt to EBITDA ratio of around 1.9 suggests only moderate debt usage. And its strong interest coverage of 15.8 times makes us even more comfortable. We have seen Church & Dwight increase its EBIT by 4.6% over the last twelve months. It’s far from amazing, but it’s a good thing when it comes to paying down debt. The balance sheet is clearly the area to focus on when analyzing debt. But ultimately, the company’s future profitability will decide whether Church & Dwight can strengthen its balance sheet over time. So if you are focused on the future, you can check out this free report showing analyst earnings forecasts.
Finally, a business needs free cash flow to pay off its debts; book profits are not enough. We therefore always check how much of this EBIT is converted into free cash flow. Over the past three years, Church & Dwight has generated free cash flow of a very strong 87% of EBIT, more than we expected. This positions him well to pay off debt if desired.
Our point of view
Church & Dwight’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 doesn’t stop there, since its conversion of EBIT into free cash flow also confirms this impression! When we consider the range of factors above, it seems that Church & Dwight is quite sensitive with its use of debt. While this carries some risk, it can also improve shareholder returns. When analyzing debt levels, the balance sheet is the obvious starting point. However, not all investment risks reside on the balance sheet, far from it. We have identified 1 warning sign with Church & Dwight and understanding them should be part of your investment process.
If after all this you are more interested in a fast growing company with a strong balance sheet, then check out our list of net cash growth stocks without delay.
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