These 4 Measures Indicate That Compagnie Générale des Établissements Michelin Société en commandite par actions (EPA:ML) Is Using Debt Reasonably Well

Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' 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. We note that Compagnie Générale des Établissements Michelin Société en commandite par actions (EPA:ML) does have debt on its balance sheet. But is this debt a concern to shareholders?

Why Does Debt Bring Risk?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. 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. The first step when considering a company's debt levels is to consider its 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?

As you can see below, at the end of June 2023, Compagnie Générale des Établissements Michelin Société en commandite par actions had €7.16b of debt, up from €6.56b a year ago. Click the image for more detail. On the flip side, it has €2.86b in cash leading to net debt of about €4.30b.

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

According to the last reported balance sheet, Compagnie Générale des Établissements Michelin Société en commandite par actions had liabilities of €9.01b due within 12 months, and liabilities of €9.08b due beyond 12 months. On the other hand, it had cash of €2.86b and €4.18b worth of receivables due within a year. So it has liabilities totalling €11.0b more than its cash and near-term receivables, combined.

This deficit isn't so bad because Compagnie Générale des Établissements Michelin Société en commandite par actions is worth a massive €20.3b, 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). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

Compagnie Générale des Établissements Michelin Société en commandite par actions has a low net debt to EBITDA ratio of only 0.82. And its EBIT covers its interest expense a whopping 13.1 times over. 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 15% over the last year, further increasing its ability to manage debt. 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 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. In the last three years, Compagnie Générale des Établissements Michelin Société en commandite par actions's free cash flow amounted to 39% of its EBIT, less 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 instance it seems like it has to struggle a bit to handle its total liabilities. When we consider all the elements mentioned above, it seems to us that Compagnie Générale des Établissements Michelin Société en commandite par actions is managing its debt quite well. 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. But ultimately, every company can contain risks that exist outside of the balance sheet. We've identified 1 warning sign with Compagnie Générale des Établissements Michelin Société en commandite par actions , and understanding them should be part of your investment process.

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

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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.