We Think Costco Wholesale (NASDAQ:COST) Can Stay On Top Of Its Debt

Stock Analysis

Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. As with many other companies Costco Wholesale Corporation (NASDAQ:COST) makes use of debt. But the more important question is: how much risk is that debt creating?

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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

Check out our latest analysis for Costco Wholesale

The chart below, which you can click on for greater detail, shows that Costco Wholesale had US$6.50b in debt in May 2023; about the same as the year before. But on the other hand it also has US$13.7b in cash, leading to a US$7.21b net cash position.

We can see from the most recent balance sheet that Costco Wholesale had liabilities of US$31.7b falling due within a year, and liabilities of US$11.5b due beyond that. On the other hand, it had cash of US$13.7b and US$2.50b worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by US$27.0b.

Of course, Costco Wholesale has a titanic market capitalization of US$236.6b, so these liabilities are probably manageable. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time. Despite its noteworthy liabilities, Costco Wholesale boasts net cash, so it's fair to say it does not have a heavy debt load!

Costco Wholesale's EBIT was pretty flat over the last year, but that shouldn't be an issue given the it doesn't have a lot of debt. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Costco Wholesale's ability to maintain a healthy balance sheet going forward. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. While Costco Wholesale has net cash on its balance sheet, it's still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. Over the most recent three years, Costco Wholesale recorded free cash flow worth 74% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This free cash flow puts the company in a good position to pay down debt, when appropriate.

While Costco Wholesale does have more liabilities than liquid assets, it also has net cash of US$7.21b. The cherry on top was that in converted 74% of that EBIT to free cash flow, bringing in US$5.8b. So is Costco Wholesale's debt a risk? It doesn't seem so to us. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. Case in point: We've spotted 1 warning sign for Costco Wholesale you should be aware of.

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.

Find out whether Costco Wholesale is potentially over or undervalued by checking out our comprehensive analysis, which includes fair value estimates, risks and warnings, dividends, insider transactions and financial health.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.

Costco Wholesale Corporation, together with its subsidiaries, engages in the operation of membership warehouses in the United States, Puerto Rico, Canada, the United Kingdom, Mexico, Japan, Korea, Australia, Spain, France, Iceland, China, and Taiwan.

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