Compagnie de Saint-Gobain (EPA:SGO) Seems To Use Debt Quite Sensibly

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. As with many other companies Compagnie de Saint-Gobain S.A. (EPA:SGO) makes use of debt. But should shareholders be worried about its use of debt?

What Risk Does Debt Bring?

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. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. Of course, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. The first step when considering a company's debt levels is to consider its cash and debt together.

Our analysis indicates that SGO is potentially undervalued!

What Is Compagnie de Saint-Gobain's Net Debt?

You can click the graphic below for the historical numbers, but it shows that as of June 2022 Compagnie de Saint-Gobain had €12.0b of debt, an increase on €11.1b, over one year. On the flip side, it has €6.94b in cash leading to net debt of about €5.03b.

A Look At Compagnie de Saint-Gobain's Liabilities

According to the last reported balance sheet, Compagnie de Saint-Gobain had liabilities of €18.4b due within 12 months, and liabilities of €14.1b due beyond 12 months. Offsetting these obligations, it had cash of €6.94b as well as receivables valued at €8.18b due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by €17.4b.

This is a mountain of leverage even relative to its gargantuan market capitalization of €23.8b. Should its lenders demand that it shore up the balance sheet, shareholders would likely face severe 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 de Saint-Gobain's net debt is only 0.84 times its EBITDA. And its EBIT covers its interest expense a whopping 18.1 times over. So we're pretty relaxed about its super-conservative use of debt. The good news is that Compagnie de Saint-Gobain has increased its EBIT by 9.8% over twelve months, which should ease any concerns about debt repayment. 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 de Saint-Gobain 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 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. Over the last three years, Compagnie de Saint-Gobain recorded free cash flow worth a fulsome 83% of its EBIT, which is stronger than we'd usually expect. That positions it well to pay down debt if desirable to do so.

Our View

Happily, Compagnie de Saint-Gobain's impressive interest cover implies it has the upper hand on its debt. But, on a more sombre note, we are a little concerned by its level of total liabilities. Looking at all the aforementioned factors together, it strikes us that Compagnie de Saint-Gobain can handle its debt fairly comfortably. Of course, while this leverage can enhance returns on equity, it does bring more risk, so it's worth keeping an eye on this one. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. These risks can be hard to spot. Every company has them, and we've spotted 1 warning sign for Compagnie de Saint-Gobain you should know about.

If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.

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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.