Here's Why Compagnie de Saint-Gobain (EPA:SGO) Can Manage Its Debt Responsibly

Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' 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. 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?

Why Does Debt Bring Risk?

Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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 Compagnie de Saint-Gobain

How Much Debt Does Compagnie de Saint-Gobain Carry?

As you can see below, at the end of June 2024, Compagnie de Saint-Gobain had €14.5b of debt, up from €12.2b a year ago. Click the image for more detail. However, it does have €8.17b in cash offsetting this, leading to net debt of about €6.38b.

A Look At Compagnie de Saint-Gobain's Liabilities

According to the last reported balance sheet, Compagnie de Saint-Gobain had liabilities of €16.5b due within 12 months, and liabilities of €18.5b due beyond 12 months. Offsetting these obligations, it had cash of €8.17b as well as receivables valued at €7.40b due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by €19.4b.

While this might seem like a lot, it is not so bad since Compagnie de Saint-Gobain has a huge market capitalization of €36.9b, and so it could probably strengthen its balance sheet by raising capital if it needed to. But we definitely want to keep our eyes open to indications that its debt is bringing too much risk.

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

Compagnie de Saint-Gobain has a low net debt to EBITDA ratio of only 0.98. And its EBIT easily covers its interest expense, being 25.7 times the size. So you could argue it is no more threatened by its debt than an elephant is by a mouse. Compagnie de Saint-Gobain's EBIT was pretty flat over the last year, but that shouldn't be an issue given the it doesn't have a lot of debt. The balance sheet is clearly the area to focus on when you are analysing debt. But it is future earnings, more than anything, that will determine Compagnie de Saint-Gobain's ability to maintain a healthy balance sheet going forward. 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 it's worth checking how much of that EBIT is backed by free cash flow. During the last three years, Compagnie de Saint-Gobain produced sturdy free cash flow equating to 71% of its EBIT, about what we'd expect. This cold hard cash means it can reduce its debt when it wants to.

Our View

Happily, Compagnie de Saint-Gobain's impressive interest cover implies it has the upper hand on its debt. But truth be told we feel its level of total liabilities does undermine this impression a bit. Looking at all the aforementioned factors together, it strikes us that Compagnie de Saint-Gobain can handle its debt fairly comfortably. On the plus side, this leverage can boost shareholder returns, but the potential downside is more risk of loss, so it's worth monitoring the balance sheet. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. We've identified 1 warning sign with Compagnie de Saint-Gobain , and understanding them should be part of your investment process.

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.