Does Ecolab (NYSE:ECL) Have A Healthy Balance Sheet?

Simply Wall St · 10/15 10:36

Warren Buffett famously said, 'Volatility is far from synonymous with risk.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. We note that Ecolab Inc. (NYSE:ECL) does have debt on its balance sheet. But is this debt a concern to shareholders?

When Is Debt A Problem?

Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we think about a company's use of debt, we first look at cash and debt together.

See our latest analysis for Ecolab

What Is Ecolab's Debt?

You can click the graphic below for the historical numbers, but it shows that Ecolab had US$7.53b of debt in June 2024, down from US$8.61b, one year before. On the flip side, it has US$384.0m in cash leading to net debt of about US$7.14b.

debt-equity-history-analysis
NYSE:ECL Debt to Equity History October 15th 2024

A Look At Ecolab's Liabilities

Zooming in on the latest balance sheet data, we can see that Ecolab had liabilities of US$3.85b due within 12 months and liabilities of US$9.31b due beyond that. Offsetting this, it had US$384.0m in cash and US$3.04b in receivables that were due within 12 months. So its liabilities total US$9.73b more than the combination of its cash and short-term receivables.

Since publicly traded Ecolab shares are worth a very impressive total of US$72.3b, it seems unlikely that this level of liabilities would be a major threat. Having said that, it's clear that we should continue to monitor its balance sheet, lest it change for the worse.

In order to size up a company's debt relative to its earnings, we calculate its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and its earnings before interest and tax (EBIT) divided by its interest expense (its interest cover). The advantage of this approach is that we take into account both the absolute quantum of debt (with net debt to EBITDA) and the actual interest expenses associated with that debt (with its interest cover ratio).

With a debt to EBITDA ratio of 2.1, Ecolab uses debt artfully but responsibly. And the fact that its trailing twelve months of EBIT was 8.5 times its interest expenses harmonizes with that theme. We note that Ecolab grew its EBIT by 27% in the last year, and that should make it easier to pay down debt, going forward. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Ecolab's ability to maintain a healthy balance sheet going forward. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. So we always check how much of that EBIT is translated into free cash flow. During the last three years, Ecolab produced sturdy free cash flow equating to 70% of its EBIT, about what we'd expect. This cold hard cash means it can reduce its debt when it wants to.

Our View

Ecolab's EBIT growth rate suggests it can handle its debt as easily as Cristiano Ronaldo could score a goal against an under 14's goalkeeper. And the good news does not stop there, as its conversion of EBIT to free cash flow also supports that impression! Looking at the bigger picture, we think Ecolab's use of debt seems quite reasonable and we're not concerned about it. While debt does bring risk, when used wisely it can also bring a higher return on equity. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. Be aware that Ecolab is showing 1 warning sign in our investment analysis , you should know about...

When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.