Is Compagnie d'Entreprises CFE (EBR:CFEB) A Risky Investment?

Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk.' 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. Importantly, Compagnie d'Entreprises CFE SA (EBR:CFEB) does carry debt. But the more important question is: how much risk is that debt creating?

When Is Debt Dangerous?

Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. If things get really bad, the lenders can take control of the business. 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. Of course, plenty of companies use debt to fund growth, without any negative consequences. 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

How Much Debt Does Compagnie d'Entreprises CFE Carry?

You can click the graphic below for the historical numbers, but it shows that Compagnie d'Entreprises CFE had €163.2m of debt in June 2022, down from €1.03b, one year before. However, because it has a cash reserve of €139.0m, its net debt is less, at about €24.3m.

How Strong Is Compagnie d'Entreprises CFE's Balance Sheet?

We can see from the most recent balance sheet that Compagnie d'Entreprises CFE had liabilities of €683.8m falling due within a year, and liabilities of €179.2m due beyond that. Offsetting these obligations, it had cash of €139.0m as well as receivables valued at €313.1m due within 12 months. So its liabilities total €411.0m more than the combination of its cash and short-term receivables.

This deficit casts a shadow over the €247.1m company, like a colossus towering over mere mortals. So we definitely think shareholders need to watch this one closely. At the end of the day, Compagnie d'Entreprises CFE would probably need a major re-capitalization if its creditors were to demand repayment.

We use two main ratios to inform us about debt levels relative to earnings. The first is net debt divided by earnings before interest, tax, depreciation, and amortization (EBITDA), while the second is how many times its earnings before interest and tax (EBIT) covers its interest expense (or its interest cover, for short). 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 0.34. And its EBIT easily covers its interest expense, being 22.0 times the size. So you could argue it is no more threatened by its debt than an elephant is by a mouse. In fact Compagnie d'Entreprises CFE's saving grace is its low debt levels, because its EBIT has tanked 47% in the last twelve months. When it comes to paying off debt, falling earnings are no more useful than sugary sodas are for your health. 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 want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So we always check how much of that EBIT is translated into free cash flow. Over the last three years, Compagnie d'Entreprises CFE actually produced more free cash flow than EBIT. That sort of strong cash generation warms our hearts like a puppy in a bumblebee suit.

Our View

To be frank both Compagnie d'Entreprises CFE's EBIT growth rate and its track record of staying on top of its total liabilities make us rather uncomfortable with its debt levels. But at least it's pretty decent at covering its interest expense with its EBIT; that's encouraging. Once we consider all the factors above, together, it seems to us that Compagnie d'Entreprises CFE's debt is making it a bit risky. That's not necessarily a bad thing, but we'd generally feel more comfortable with less leverage. 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. We've identified 1 warning sign with Compagnie d'Entreprises CFE , and understanding them should be part of your investment process.

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

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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.