Bouygues (EPA:EN) Takes On Some Risk With Its Use Of Debt

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.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. Importantly, Bouygues SA (EPA:EN) does carry debt. But should shareholders be worried about its use of debt?

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. If things get really bad, the lenders can take control of the business. 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. 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 Bouygues

What Is Bouygues's Net Debt?

You can click the graphic below for the historical numbers, but it shows that Bouygues had €12.0b of debt in June 2024, down from €12.9b, one year before. However, it does have €3.25b in cash offsetting this, leading to net debt of about €8.77b.

How Strong Is Bouygues' Balance Sheet?

According to the last reported balance sheet, Bouygues had liabilities of €31.1b due within 12 months, and liabilities of €16.2b due beyond 12 months. Offsetting these obligations, it had cash of €3.25b as well as receivables valued at €22.0b due within 12 months. So its liabilities total €22.0b more than the combination of its cash and short-term receivables.

This deficit casts a shadow over the €11.1b company, like a colossus towering over mere mortals. So we'd watch its balance sheet closely, without a doubt. After all, Bouygues would likely require a major re-capitalisation if it had to pay its creditors today.

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). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

Bouygues has net debt worth 2.1 times EBITDA, which isn't too much, but its interest cover looks a bit on the low side, with EBIT at only 5.2 times the interest expense. In large part that's due to the company's significant depreciation and amortisation charges, which arguably mean its EBITDA is a very generous measure of earnings, and its debt may be more of a burden than it first appears. One way Bouygues could vanquish its debt would be if it stops borrowing more but continues to grow EBIT at around 10%, as it did over the last year. 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 Bouygues 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, a business needs free cash flow to pay off debt; accounting profits just don't cut it. So it's worth checking how much of that EBIT is backed by free cash flow. During the last three years, Bouygues generated free cash flow amounting to a very robust 80% of its EBIT, more than we'd expect. That puts it in a very strong position to pay down debt.

Our View

Bouygues's level of total liabilities and net debt to EBITDA definitely weigh on it, in our esteem. But the good news is it seems to be able to convert EBIT to free cash flow with ease. Taking the abovementioned factors together we do think Bouygues's debt poses some risks to the business. While that debt can boost returns, we think the company has enough leverage now. 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 - Bouygues has 1 warning sign we think you should be aware of.

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

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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.