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

Warren Buffett famously said, 'Volatility is far from synonymous with risk.' 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 is this debt a concern to shareholders?

When Is Debt Dangerous?

Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

See 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 Net Debt?

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 €6.79b of debt in June 2024, down from €7.16b, one year before. However, it does have €3.08b in cash offsetting this, leading to net debt of about €3.71b.

How Strong 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 €8.20b due within a year, and liabilities of €10.3b falling due after that. Offsetting these obligations, it had cash of €3.08b as well as receivables valued at €4.00b due within 12 months. So it has liabilities totalling €11.4b 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 €22.0b, 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.

We measure a company's debt load relative to its earnings power by looking at its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and by calculating how easily its earnings before interest and tax (EBIT) cover its interest expense (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 0.71. And its EBIT easily covers its interest expense, being 38.4 times the size. So we're pretty relaxed about its super-conservative use of debt. While Compagnie Générale des Établissements Michelin Société en commandite par actions doesn't seem to have gained much on the EBIT line, at least earnings remain stable for now. 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're focused on the future you can check out this free report showing analyst profit forecasts.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. So the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. Looking at the most recent three years, Compagnie Générale des Établissements Michelin Société en commandite par actions recorded free cash flow of 44% of its EBIT, which is weaker than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.

Our View

When it comes to the balance sheet, the standout positive for Compagnie Générale des Établissements Michelin Société en commandite par actions was the fact that it seems able to cover its interest expense with its EBIT confidently. However, our other observations weren't so heartening. For example, its level of total liabilities makes us a little nervous about its debt. 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. But a word of caution: we think debt levels are high enough to justify ongoing monitoring. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. These risks can be hard to spot. Every company has them, and we've spotted 2 warning signs for Compagnie Générale des Établissements Michelin Société en commandite par actions you should know about.

When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.

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.