Is Compagnie d'Entreprises CFE (EBR:CFEB) Using Too Much Debt?

Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' 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. We can see that Compagnie d'Entreprises CFE SA (EBR:CFEB) does use debt in its business. But the more important question is: how much risk is that debt creating?

Why Does Debt Bring Risk?

Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. If things get really bad, the lenders can take control of the business. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. Of course, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. When we think about a company's use of debt, we first look at cash and debt together.

View our latest analysis for Compagnie d'Entreprises CFE

What Is Compagnie d'Entreprises CFE's Debt?

You can click the graphic below for the historical numbers, but it shows that Compagnie d'Entreprises CFE had €258.0m of debt in December 2021, down from €1.26b, one year before. However, it does have €159.3m in cash offsetting this, leading to net debt of about €98.7m.

A Look At Compagnie d'Entreprises CFE's Liabilities

The latest balance sheet data shows that Compagnie d'Entreprises CFE had liabilities of €3.20b due within a year, and liabilities of €142.2m falling due after that. On the other hand, it had cash of €159.3m and €281.3m worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by €2.90b.

Given this deficit is actually higher than the company's market capitalization of €2.69b, we think shareholders really should watch Compagnie d'Entreprises CFE's debt levels, like a parent watching their child ride a bike for the first time. Hypothetically, extremely heavy dilution would be required if the company were forced to pay down its liabilities by raising capital at the current share price.

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). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

Compagnie d'Entreprises CFE has a low net debt to EBITDA ratio of only 1.4. And its EBIT covers its interest expense a whopping 14.0 times over. 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 748% last year, which is an impressive improvement. That boost will make it even easier to pay down debt going forward. There's no doubt that we learn most about debt from the balance sheet. But it is future earnings, more than anything, that will determine Compagnie d'Entreprises CFE'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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. Happily for any shareholders, Compagnie d'Entreprises CFE actually produced more free cash flow than EBIT over the last three years. There's nothing better than incoming cash when it comes to staying in your lenders' good graces.

Our View

Compagnie d'Entreprises CFE's interest cover suggests it can handle its debt as easily as Cristiano Ronaldo could score a goal against an under 14's goalkeeper. But we must concede we find its level of total liabilities has the opposite effect. All these things considered, it appears that Compagnie d'Entreprises CFE can comfortably handle its current debt levels. Of course, while this leverage can enhance returns on equity, it does bring more risk, so it's worth keeping an eye on this one. Above most other metrics, we think its important to track how fast earnings per share is growing, if at all. If you've also come to that realization, you're in luck, because today you can view this interactive graph of Compagnie d'Entreprises CFE's earnings per share history for free.

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

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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.