Here's Why Compagnie Générale des Établissements Michelin Société en commandite par actions (EPA:ML) Can Manage Its Debt Responsibly

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.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. We note that Compagnie Générale des Établissements Michelin Société en commandite par actions (EPA:ML) does have debt on its balance sheet. But the more important question is: how much risk is that debt creating?

What Risk Does Debt Bring?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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, debt can be an important tool in businesses, particularly capital heavy businesses. When we examine debt levels, we first consider both cash and debt levels, 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?

You can click the graphic below for the historical numbers, but it shows that Compagnie Générale des Établissements Michelin Société en commandite par actions had €7.04b of debt in December 2021, down from €7.72b, one year before. On the flip side, it has €4.92b in cash leading to net debt of about €2.13b.

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

The latest balance sheet data shows that Compagnie Générale des Établissements Michelin Société en commandite par actions had liabilities of €9.02b due within a year, and liabilities of €10.7b falling due after that. Offsetting these obligations, it had cash of €4.92b as well as receivables valued at €4.07b due within 12 months. So it has liabilities totalling €10.7b more than its cash and near-term receivables, combined.

Compagnie Générale des Établissements Michelin Société en commandite par actions has a very large market capitalization of €21.3b, so it could very likely raise cash to ameliorate its balance sheet, if the need arose. 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). The advantage of this approach is that we take into account both the absolute quantum of debt (with net debt to EBITDA) and the actual interest expenses associated with that debt (with its interest cover ratio).

Compagnie Générale des Établissements Michelin Société en commandite par actions has a low net debt to EBITDA ratio of only 0.48. And its EBIT covers its interest expense a whopping 13.3 times over. So you could argue it is no more threatened by its debt than an elephant is by a mouse. 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. 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 want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So we always check how much of that EBIT is translated into free cash flow. During the last three years, Compagnie Générale des Établissements Michelin Société en commandite par actions produced sturdy free cash flow equating to 63% of its EBIT, about what we'd expect. 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 suggests it can handle its debt as easily as Cristiano Ronaldo could score a goal against an under 14's goalkeeper. But, on a more sombre note, we are a little concerned by its level of total liabilities. Looking at the bigger picture, we think Compagnie Générale des Établissements Michelin Société en commandite par actions's use of debt seems quite reasonable and we're not concerned about it. While debt does bring risk, when used wisely it can also bring a higher return 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. Case in point: We've spotted 2 warning signs for Compagnie Générale des Établissements Michelin Société en commandite par actions you should be aware of.

If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

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.