Compagnie Générale des Établissements Michelin Société en commandite par actions (EPA:ML) Has A Pretty Healthy Balance Sheet

The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' 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. Importantly, Compagnie Générale des Établissements Michelin Société en commandite par actions (EPA:ML) does carry debt. But the real question is whether this debt is making the company risky.

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. If things get really bad, the lenders can take control of the business. 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. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. 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 Générale des Établissements Michelin Société en commandite par actions

How Much Debt Does Compagnie Générale des Établissements Michelin Société en commandite par actions Carry?

As you can see below, Compagnie Générale des Établissements Michelin Société en commandite par actions had €7.04b of debt at December 2021, down from €7.72b a year prior. However, because it has a cash reserve of €4.92b, its net debt is less, at about €2.13b.

How Strong Is Compagnie Générale des Établissements Michelin Société en commandite par actions' Balance Sheet?

According to the last reported balance sheet, Compagnie Générale des Établissements Michelin Société en commandite par actions had liabilities of €9.02b due within 12 months, and liabilities of €10.7b due beyond 12 months. Offsetting this, it had €4.92b in cash and €4.22b in receivables that were due within 12 months. So its liabilities total €10.6b more than the combination of its cash and short-term receivables.

While this might seem like a lot, it is not so bad since Compagnie Générale des Établissements Michelin Société en commandite par actions has a huge market capitalization of €18.5b, and so it could probably strengthen its balance sheet by raising capital if it needed to. But it's clear that we should definitely closely examine whether it can manage its debt without dilution.

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 Générale des Établissements Michelin Société en commandite par actions's net debt is only 0.48 times its EBITDA. And its EBIT easily covers its interest expense, being 14.0 times the size. So we're pretty relaxed about its super-conservative use of debt. In addition to that, we're happy to report that Compagnie Générale des Établissements Michelin Société en commandite par actions has boosted its EBIT by 59%, thus reducing the spectre of future debt repayments. 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 Générale des Établissements Michelin Société en commandite par actions 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.

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. Over the most recent three years, Compagnie Générale des Établissements Michelin Société en commandite par actions recorded free cash flow worth 69% 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.

Our View

The good news is that Compagnie Générale des Établissements Michelin Société en commandite par actions's demonstrated ability to cover its interest expense with its EBIT delights us like a fluffy puppy does a toddler. But, on a more sombre note, we are a little concerned by its level of total liabilities. Zooming out, Compagnie Générale des Établissements Michelin Société en commandite par actions seems to use debt quite reasonably; and that gets the nod from us. After all, sensible leverage can boost returns on equity. 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. We've identified 1 warning sign with Compagnie Générale des Établissements Michelin Société en commandite par actions , and understanding them should be part of your investment process.

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.