These 4 Measures Indicate That Compagnie de Saint-Gobain (EPA:SGO) Is Using Debt Safely

By
Simply Wall St
Published
August 10, 2021
ENXTPA:SGO
Source: Shutterstock

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 seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. We note that Compagnie de Saint-Gobain S.A. (EPA:SGO) does have debt on its balance sheet. But the more important question is: how much risk is that debt creating?

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. If things get really bad, the lenders can take control of the business. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. 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 de Saint-Gobain

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

The image below, which you can click on for greater detail, shows that Compagnie de Saint-Gobain had debt of €11.1b at the end of June 2021, a reduction from €13.7b over a year. However, because it has a cash reserve of €6.60b, its net debt is less, at about €4.54b.

debt-equity-history-analysis
ENXTPA:SGO Debt to Equity History August 10th 2021

How Strong Is Compagnie de Saint-Gobain's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Compagnie de Saint-Gobain had liabilities of €14.3b due within 12 months and liabilities of €15.7b due beyond that. Offsetting this, it had €6.60b in cash and €7.21b in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by €16.2b.

Compagnie de Saint-Gobain has a very large market capitalization of €33.8b, so it could very likely raise cash to ameliorate its balance sheet, if the need arose. But we definitely want to keep our eyes open to indications that its debt is bringing too much risk.

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). 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 0.81. And its EBIT easily covers its interest expense, being 12.4 times the size. So we're pretty relaxed about its super-conservative use of debt. On top of that, Compagnie de Saint-Gobain grew its EBIT by 72% over the last twelve months, and that growth will make it easier to handle its 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're focused on the future you can check out this free report showing analyst profit forecasts.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. So we clearly need to look at whether that EBIT is leading to corresponding 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

The good news is that Compagnie de Saint-Gobain's demonstrated ability to cover its interest expense with its EBIT delights us like a fluffy puppy does a toddler. But truth be told we feel its level of total liabilities does undermine this impression a bit. Zooming out, Compagnie de Saint-Gobain seems to use debt quite reasonably; and that gets the nod from us. After all, sensible leverage can boost returns on equity. 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. To that end, you should be aware of the 2 warning signs we've spotted with Compagnie de Saint-Gobain .

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

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