Compagnie Plastic Omnium (EPA:POM) Has A Somewhat Strained Balance Sheet

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 can see that Compagnie Plastic Omnium SE (EPA:POM) does use debt in its business. But is this debt a concern to shareholders?

When Is Debt A Problem?

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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

View our latest analysis for Compagnie Plastic Omnium

How Much Debt Does Compagnie Plastic Omnium Carry?

The chart below, which you can click on for greater detail, shows that Compagnie Plastic Omnium had €1.98b in debt in December 2023; about the same as the year before. However, because it has a cash reserve of €637.4m, its net debt is less, at about €1.34b.

How Healthy Is Compagnie Plastic Omnium's Balance Sheet?

We can see from the most recent balance sheet that Compagnie Plastic Omnium had liabilities of €4.41b falling due within a year, and liabilities of €1.16b due beyond that. On the other hand, it had cash of €637.4m and €1.38b worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by €3.55b.

The deficiency here weighs heavily on the €1.67b company itself, as if a child were struggling under the weight of an enormous back-pack full of books, his sports gear, and a trumpet. So we'd watch its balance sheet closely, without a doubt. After all, Compagnie Plastic Omnium would likely require a major re-capitalisation if it had to pay its creditors today.

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). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

Compagnie Plastic Omnium's net debt is sitting at a very reasonable 2.1 times its EBITDA, while its EBIT covered its interest expense just 3.7 times last year. While that doesn't worry us too much, it does suggest the interest payments are somewhat of a burden. If Compagnie Plastic Omnium can keep growing EBIT at last year's rate of 12% over the last year, then it will find its debt load easier to manage. 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 Plastic Omnium 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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So we always check how much of that EBIT is translated into free cash flow. In the last three years, Compagnie Plastic Omnium's free cash flow amounted to 49% of its EBIT, less than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.

Our View

We'd go so far as to say Compagnie Plastic Omnium's level of total liabilities was disappointing. But at least it's pretty decent at growing its EBIT; that's encouraging. Overall, we think it's fair to say that Compagnie Plastic Omnium has enough debt that there are some real risks around the balance sheet. If all goes well, that should boost returns, but on the flip side, the risk of permanent capital loss is elevated by the debt. 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. Be aware that Compagnie Plastic Omnium is showing 2 warning signs in our investment analysis , you should know about...

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.