Compagnie d'Entreprises CFE (EBR:CFEB) Has A Pretty Healthy Balance Sheet

Warren Buffett famously said, 'Volatility is far from synonymous with risk.' So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. As with many other companies Compagnie d'Entreprises CFE SA (EBR:CFEB) makes use of debt. But is this debt a concern to shareholders?

When Is Debt A Problem?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. 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.

View our latest analysis for Compagnie d'Entreprises CFE

What Is Compagnie d'Entreprises CFE's Net Debt?

The image below, which you can click on for greater detail, shows that Compagnie d'Entreprises CFE had debt of €1.03b at the end of June 2021, a reduction from €1.48b over a year. On the flip side, it has €450.6m in cash leading to net debt of about €582.2m.

A Look At Compagnie d'Entreprises CFE's Liabilities

The latest balance sheet data shows that Compagnie d'Entreprises CFE had liabilities of €2.05b due within a year, and liabilities of €1.09b falling due after that. Offsetting these obligations, it had cash of €450.6m as well as receivables valued at €954.4m due within 12 months. So it has liabilities totalling €1.74b more than its cash and near-term receivables, combined.

This is a mountain of leverage relative to its market capitalization of €2.38b. This suggests shareholders would be heavily diluted if the company needed to shore up its balance sheet in a hurry.

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). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

Compagnie d'Entreprises CFE has a low net debt to EBITDA ratio of only 1.3. And its EBIT easily covers its interest expense, being 10.7 times the size. So you could argue it is no more threatened by its debt than an elephant is by a mouse. Better yet, Compagnie d'Entreprises CFE grew its EBIT by 288% last year, which is an impressive improvement. If maintained that growth will make the debt even more manageable in the years ahead. There's no doubt that we learn most about debt from the balance sheet. But ultimately the future profitability of the business will decide if Compagnie d'Entreprises CFE can strengthen its balance sheet over time. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. So it's worth checking how much of that EBIT is backed by free cash flow. Looking at the most recent three years, Compagnie d'Entreprises CFE recorded free cash flow of 35% of its EBIT, which is weaker than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.

Our View

Compagnie d'Entreprises CFE's EBIT growth rate was a real positive on this analysis, as was its interest cover. Having said that, its level of total liabilities somewhat sensitizes us to potential future risks to the balance sheet. Considering this range of data points, we think Compagnie d'Entreprises CFE is in a good position to manage its debt levels. But a word of caution: we think debt levels are high enough to justify ongoing monitoring. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. Case in point: We've spotted 1 warning sign for Compagnie d'Entreprises CFE 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.

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.

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