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

The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' 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. 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 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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. The first thing to do when considering how much debt a business uses is to look at 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?

You can click the graphic below for the historical numbers, but it shows that as of June 2023 Compagnie Générale des Établissements Michelin Société en commandite par actions had €7.16b of debt, an increase on €6.56b, over one year. However, it does have €2.86b in cash offsetting this, 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. Offsetting these obligations, it had cash of €2.86b as well as receivables valued at €4.18b due within 12 months. So its liabilities total €11.0b more than the combination of its cash and short-term receivables.

This deficit isn't so bad because Compagnie Générale des Établissements Michelin Société en commandite par actions is worth a massive €21.4b, 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.

We use two main ratios to inform us about debt levels relative to earnings. The first is net debt divided by earnings before interest, tax, depreciation, and amortization (EBITDA), while the second is how many times its earnings before interest and tax (EBIT) covers its interest expense (or its interest cover, for short). 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's net debt is only 0.82 times its EBITDA. And its EBIT covers its interest expense a whopping 13.1 times over. So we're pretty relaxed about its super-conservative use of debt. 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. When analysing debt levels, the balance sheet is the obvious place to start. 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. Looking at the most recent three years, Compagnie Générale des Établissements Michelin Société en commandite par actions recorded free cash flow of 39% 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 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. But a word of caution: we think debt levels are high enough to justify ongoing monitoring. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. For example - Compagnie Générale des Établissements Michelin Société en commandite par actions has 1 warning sign we think you should be aware of.

At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.

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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.