Coty (NYSE: COTY) has a somewhat strained record

Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett said “volatility is far from risk.” So it seems like smart money knows that debt – which is usually involved in bankruptcies – is a very important factor, when you assess the level of risk of a business. Like many other companies Coty Inc. (NYSE: COTY) uses debt. But does this debt worry shareholders?

What risk does debt entail?

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. If things really go wrong, lenders can take over the business. However, a more common (but still costly) situation is where a company has to dilute its shareholders at a cheap share price just to get its debt under control. Of course, the advantage of debt is that it often represents cheap capital, especially when it replaces dilution of a business with the ability to reinvest at high rates of return. The first thing to do when considering how much debt a business uses is to look at its cash flow and debt together.

What is Coty’s net debt?

As you can see below, Coty had $ 5.28 billion in debt in September 2021, up from $ 8.33 billion the year before. On the flip side, it has $ 376.9 million in cash, resulting in net debt of around $ 4.90 billion.

NYSE: COTY Debt to Equity History December 31, 2021

Is Coty’s track record healthy?

The latest balance sheet data shows Coty had $ 2.68 billion in liabilities due within one year, and $ 6.99 billion in liabilities due after that. In return, he had $ 376.9 million in cash and $ 678.5 million in receivables due within 12 months. It therefore has liabilities totaling US $ 8.61 billion more than its cash and short-term receivables combined.

This deficit is sizable compared to its market cap of $ 8.71 billion, so he suggests shareholders keep an eye on Coty’s use of debt. If its lenders asked it to consolidate the balance sheet, shareholders would likely face severe dilution.

We measure a company’s indebtedness relative to its earning power by looking at its net debt divided by its earnings before interest, taxes, depreciation, and amortization (EBITDA) and calculating the ease with which its earnings before interest and taxes (EBIT ) covers its interests. costs (interest coverage). In this way, we consider both the absolute amount of debt, as well as the interest rates paid on it.

Coty shareholders face the double whammy of a high net debt to EBITDA ratio (6.5) and fairly low interest coverage, since EBIT is only 0.77 times the expenses of ‘interests. This means that we would consider him to be in heavy debt. A buyout factor for Coty is that he turned last year’s loss of EBIT into a gain of US $ 180 million, over the past twelve months. There is no doubt that we learn the most about debt from the balance sheet. But it’s future earnings, more than anything, that will determine Coty’s ability to maintain a healthy balance sheet going forward. So if you are focused on the future you can check this out free report showing analysts’ earnings forecasts.

But our last consideration is also important, because a business cannot pay its debts with paper profits; he needs hard cash. It is therefore important to check to what extent its earnings before interest and taxes (EBIT) are converted into actual free cash flow. Over the past year, Coty has actually generated more free cash flow than EBIT. This kind of solid silver generation warms our hearts like a puppy in a bumblebee costume.

Our point of view

To be frank, Coty’s net debt to EBITDA and history of hedging its interest expense with its EBIT makes us rather uncomfortable with its debt levels. But at least it’s pretty decent to convert EBIT into free cash flow; it’s encouraging. Once we consider all of the above factors together, it seems Coty’s debt makes him a bit risky. Some people like this kind of risk, but we are aware of the potential pitfalls, so we would probably prefer him to carry less debt. There is no doubt that we learn the most about debt from the balance sheet. But at the end of the day, every business can contain risks that exist off the balance sheet. These risks can be difficult to spot. Every business has them, and we’ve spotted 2 warning signs for Coty you should know.

Of course, if you are the type of investor who prefers to buy stocks without going into debt, feel free to check out our exclusive list of cash net growth stocks today.

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