Is CSL (ASX:CSL) Overleveraged?

In the world of investments, the seasoned wisdom of renowned figures like Li Lu, backed by Berkshire Hathaway's Charlie Munger, echoes loud and clear: "The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital." Keeping this in mind, let's delve into CSL Limited (ASX:CSL), examining not only its market position but also the risks associated with its use of debt.

Why Does Debt Bring Risk?

Debt is a double-edged sword for businesses. While it can facilitate growth, the inability to repay lenders can lead to catastrophic consequences. The specter of 'creative destruction' looms, where failed businesses face liquidation. Moreover, companies might resort to issuing shares at reduced prices, diluting shareholders and compromising their interests. It's crucial to scrutinize how CSL employs debt and the risks it might pose.

A Look At CSL's Liabilities

Examining CSL's recent balance sheet reveals liabilities of US$4.61 billion maturing within a year and US$13.8 billion due beyond that period. Offsetting these obligations, the company holds US$1.55 billion in cash and US$1.94 billion in receivables due within the next 12 months. The balance tips, with liabilities outweighing the sum of cash and near-term receivables by US$14.9 billion.

With a substantial market capitalization of US$84.8 billion, CSL appears capable of managing these liabilities. However, ongoing vigilance is warranted, considering potential shifts in its balance sheet strength over time.

Debt Ratios and Financial Health

Two key ratios provide insights into CSL's debt levels relative to earnings. Firstly, net debt divided by earnings before interest, tax, depreciation, and amortization (EBITDA) stands at 2.3 times, indicating judicious debt utilization. The second ratio, interest cover, highlights EBIT covering interest expense 8.7 times, portraying financial stability. The confluence of these ratios suggests that CSL effectively manages its debt.

One potential avenue for CSL to reduce its debt is by maintaining its EBIT growth, which stood at an impressive 11% over the last year, while avoiding further borrowing. Yet, continual monitoring remains prudent, acknowledging the dynamic nature of financial landscapes.

Cash Flow Challenges and Future Considerations

Crucially, a company's ability to pay off debt depends on its cash reserves rather than accounting profits. CSL's free cash flow, accounting for 46% of its EBIT in the last three years, raises concerns about its cash conversion efficiency. Weak cash conversion could pose challenges in handling indebtedness effectively.

Our View: Navigating Risks and Opportunities

CSL's robust ability to cover interest expenses with EBIT, coupled with a healthy EBIT growth rate, instills confidence in its debt management. Despite the net debt to EBITDA ratio indicating a level of caution, the company seems well-positioned to handle its debt load. However, caution is advised, and ongoing scrutiny is essential, especially considering the intricate interplay of factors in the financial landscape.

In conclusion, while CSL demonstrates resilience in its financial approach, investors should remain vigilant. As with any investment, risks exist beyond the balance sheet, and a comprehensive evaluation is crucial. Notably, CSL presents itself with strengths but also has a warning sign, emphasizing the need for a nuanced assessment.