Is EssilorLuxottica Société anonyme (EPA:EL) A Risky Investment?

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. We note that EssilorLuxottica Société anonyme (EPA:EL) does have debt on its balance sheet. But is this debt a concern to shareholders?

What Risk Does Debt Bring?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. When we think about a company's use of debt, we first look at cash and debt together.

Check out our latest analysis for EssilorLuxottica Société anonyme

What Is EssilorLuxottica Société anonyme's Debt?

You can click the graphic below for the historical numbers, but it shows that as of June 2022 EssilorLuxottica Société anonyme had €11.0b of debt, an increase on €9.56b, over one year. However, it also had €3.76b in cash, and so its net debt is €7.24b.

How Healthy Is EssilorLuxottica Société anonyme's Balance Sheet?

We can see from the most recent balance sheet that EssilorLuxottica Société anonyme had liabilities of €11.2b falling due within a year, and liabilities of €13.5b due beyond that. Offsetting these obligations, it had cash of €3.76b as well as receivables valued at €3.38b due within 12 months. So it has liabilities totalling €17.7b more than its cash and near-term receivables, combined.

EssilorLuxottica Société anonyme has a very large market capitalization of €70.0b, 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.

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.

EssilorLuxottica Société anonyme has a low net debt to EBITDA ratio of only 1.5. And its EBIT easily covers its interest expense, being 25.8 times the size. So we're pretty relaxed about its super-conservative use of debt. In addition to that, we're happy to report that EssilorLuxottica Société anonyme has boosted its EBIT by 51%, thus reducing the spectre of future debt repayments. There's no doubt that we learn most about debt from the balance sheet. But ultimately the future profitability of the business will decide if EssilorLuxottica Société anonyme 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 company can only pay off debt with cold hard cash, not accounting profits. So it's worth checking how much of that EBIT is backed by free cash flow. Happily for any shareholders, EssilorLuxottica Société anonyme actually produced more free cash flow than EBIT over the last three years. That sort of strong cash conversion gets us as excited as the crowd when the beat drops at a Daft Punk concert.

Our View

The good news is that EssilorLuxottica Société anonyme's demonstrated ability to cover its interest expense with its EBIT delights us like a fluffy puppy does a toddler. And the good news does not stop there, as its conversion of EBIT to free cash flow also supports that impression! Looking at the bigger picture, we think EssilorLuxottica Société anonyme's use of debt seems quite reasonable and we're not concerned about it. While debt does bring risk, when used wisely it can also bring a higher return on equity. Over time, share prices tend to follow earnings per share, so if you're interested in EssilorLuxottica Société anonyme, you may well want to click here to check an interactive graph of its earnings per share history.

When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.

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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.