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

David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the 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. As with many other companies Compagnie Générale des Établissements Michelin Société en commandite par actions (EPA:ML) makes use of debt. But the real question is whether this debt is making the company risky.

When Is Debt A Problem?

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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. When we think about a company's use of debt, we first look at cash and debt together.

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

What Is Compagnie Générale des Établissements Michelin Société en commandite par actions's Debt?

The image below, which you can click on for greater detail, shows that Compagnie Générale des Établissements Michelin Société en commandite par actions had debt of €6.53b at the end of December 2022, a reduction from €7.04b over a year. However, it also had €2.87b in cash, and so its net debt is €3.66b.

A Look At Compagnie Générale des Établissements Michelin Société en commandite par actions' Liabilities

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 €9.04b due within 12 months and liabilities of €9.19b due beyond that. On the other hand, it had cash of €2.87b and €4.91b worth of receivables due within a year. So it has liabilities totalling €10.4b 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 €21.0b, so it could very likely raise cash to ameliorate its balance sheet, if the need arose. But we definitely want to keep our eyes open to indications that its debt is bringing too much risk.

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's net debt is only 0.72 times its EBITDA. And its EBIT easily covers its interest expense, being 11.5 times the size. So you could argue it is no more threatened by its debt than an elephant is by a mouse. Also good is that Compagnie Générale des Établissements Michelin Société en commandite par actions grew its EBIT at 14% over the last year, further increasing its ability to manage debt. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Compagnie Générale des Établissements Michelin Société en commandite par actions's ability to maintain a healthy balance sheet going forward. 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. In the last three years, Compagnie Générale des Établissements Michelin Société en commandite par actions's free cash flow amounted to 37% of its EBIT, less than we'd expect. That's not great, when it comes to paying down debt.

Our View

On our analysis Compagnie Générale des Établissements Michelin Société en commandite par actions's interest cover should signal that it won't have too much trouble with its debt. But the other factors we noted above weren't so encouraging. For instance it seems like it has to struggle a bit to handle its total liabilities. 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. 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. For example, we've discovered 1 warning sign for Compagnie Générale des Établissements Michelin Société en commandite par actions that you should be aware of before investing here.

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.