Is Compagnie Générale des Établissements Michelin Société en commandite par actions (EPA:ML) A Risky Investment?

Warren Buffett famously said, '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 can see that Compagnie Générale des Établissements Michelin Société en commandite par actions (EPA:ML) does use debt in its business. But the more important question is: how much risk is that debt creating?

Why Does Debt Bring Risk?

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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we examine debt levels, we first consider both cash and debt levels, 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 Net Debt?

As you can see below, Compagnie Générale des Établissements Michelin Société en commandite par actions had €5.26b of debt at December 2023, down from €6.53b a year prior. On the flip side, it has €2.80b in cash leading to net debt of about €2.46b.

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

We can see from the most recent balance sheet that Compagnie Générale des Établissements Michelin Société en commandite par actions had liabilities of €7.74b falling due within a year, and liabilities of €9.49b due beyond that. Offsetting these obligations, it had cash of €2.80b as well as receivables valued at €4.58b due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by €9.86b.

This deficit isn't so bad because Compagnie Générale des Établissements Michelin Société en commandite par actions is worth a massive €26.5b, and thus could probably raise enough capital to shore up 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). 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 0.48 times its EBITDA. And its EBIT easily covers its interest expense, being 19.2 times the size. So we're pretty relaxed about its super-conservative use of debt. The good news is that Compagnie Générale des Établissements Michelin Société en commandite par actions has increased its EBIT by 3.1% over twelve months, which should ease any concerns about debt repayment. There's no doubt that we learn most about debt from the balance sheet. 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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. 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 42% of its EBIT, which is weaker than we'd expect. That's not great, when it comes to paying down debt.

Our View

Both Compagnie Générale des Établissements Michelin Société en commandite par actions's ability to to cover its interest expense with its EBIT and its net debt to EBITDA gave us comfort that it can handle its debt. Having said that, its level of total liabilities 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. But ultimately, every company can contain risks that exist outside of the balance sheet. For example, we've discovered 2 warning signs for Compagnie Générale des Établissements Michelin Société en commandite par actions that you should be aware of before investing here.

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.

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