Compagnie Générale des Établissements Michelin Société en commandite par actions (EPA:ML) Seems To Use Debt Quite Sensibly

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.' 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.

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When Is Debt Dangerous?

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. 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, 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. The first step when considering a company's debt levels is to consider its cash and debt together.

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

As you can see below, at the end of December 2024, Compagnie Générale des Établissements Michelin Société en commandite par actions had €6.31b of debt, up from €5.26b a year ago. Click the image for more detail. However, because it has a cash reserve of €4.23b, its net debt is less, at about €2.08b.

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

Zooming in on the latest balance sheet data, we can see that Compagnie Générale des Établissements Michelin Société en commandite par actions had liabilities of €8.71b due within 12 months and liabilities of €10.0b due beyond that. On the other hand, it had cash of €4.23b and €4.35b worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by €10.1b.

Compagnie Générale des Établissements Michelin Société en commandite par actions has a very large market capitalization of €23.1b, so it could very likely raise cash to ameliorate its balance sheet, if the need arose. However, it is still worthwhile taking a close look at its ability to pay off debt.

See our latest analysis for Compagnie Générale des Établissements Michelin Société en commandite par actions

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 Générale des Établissements Michelin Société en commandite par actions's net debt is only 0.42 times its EBITDA. And its EBIT covers its interest expense a whopping 44.9 times over. So we're pretty relaxed about its super-conservative use of debt. On the other hand, Compagnie Générale des Établissements Michelin Société en commandite par actions saw its EBIT drop by 7.2% in the last twelve months. That sort of decline, if sustained, will obviously make debt harder to handle. The balance sheet is clearly the area to focus on when you are analysing debt. 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'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. Over the most recent three years, Compagnie Générale des Établissements Michelin Société en commandite par actions recorded free cash flow worth 52% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This cold hard cash means it can reduce its debt when it wants to.

Our View

Compagnie Générale des Établissements Michelin Société en commandite par actions's interest cover was a real positive on this analysis, as was its net debt to EBITDA. Having said that, its EBIT growth rate somewhat sensitizes us to potential future risks to the balance sheet. Considering this range of data points, we think Compagnie Générale des Établissements Michelin Société en commandite par actions is in a good position to manage its debt levels. Having said that, the load is sufficiently heavy that we would recommend any shareholders keep a close eye on it. 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. These risks can be hard to spot. Every company has them, and we've spotted 1 warning sign for Compagnie Générale des Établissements Michelin Société en commandite par actions you should know about.

At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.

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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.