These 4 Measures Indicate That LVMH Moët Hennessy - Louis Vuitton Société Européenne (EPA:MC) Is Using Debt Reasonably Well

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.' 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 LVMH Moët Hennessy - Louis Vuitton, Société Européenne (EPA:MC) does have debt on its balance sheet. But the more important question is: how much risk is that debt creating?

Why Does Debt Bring Risk?

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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. Of course, plenty of companies use debt to fund growth, without any negative consequences. 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 LVMH Moët Hennessy - Louis Vuitton Société Européenne

How Much Debt Does LVMH Moët Hennessy - Louis Vuitton Société Européenne Carry?

You can click the graphic below for the historical numbers, but it shows that as of June 2023 LVMH Moët Hennessy - Louis Vuitton Société Européenne had €22.9b of debt, an increase on €21.7b, over one year. On the flip side, it has €10.4b in cash leading to net debt of about €12.5b.

How Healthy Is LVMH Moët Hennessy - Louis Vuitton Société Européenne's Balance Sheet?

According to the last reported balance sheet, LVMH Moët Hennessy - Louis Vuitton Société Européenne had liabilities of €34.3b due within 12 months, and liabilities of €45.6b due beyond 12 months. On the other hand, it had cash of €10.4b and €7.09b worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by €62.5b.

Given LVMH Moët Hennessy - Louis Vuitton Société Européenne has a humongous market capitalization of €404.5b, it's hard to believe these liabilities pose much threat. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time.

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.

LVMH Moët Hennessy - Louis Vuitton Société Européenne has a low net debt to EBITDA ratio of only 0.50. And its EBIT easily covers its interest expense, being 46.2 times the size. So we're pretty relaxed about its super-conservative use of debt. Also good is that LVMH Moët Hennessy - Louis Vuitton Société Européenne grew its EBIT at 13% over the last year, further increasing its ability to manage debt. 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 LVMH Moët Hennessy - Louis Vuitton Société Européenne 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, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. Over the most recent three years, LVMH Moët Hennessy - Louis Vuitton Société Européenne recorded free cash flow worth 72% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This cold hard cash means it can reduce its debt when it wants to.

Our View

The good news is that LVMH Moët Hennessy - Louis Vuitton Société Européenne's demonstrated ability to cover its interest expense with its EBIT delights us like a fluffy puppy does a toddler. And that's just the beginning of the good news since its conversion of EBIT to free cash flow is also very heartening. Looking at the bigger picture, we think LVMH Moët Hennessy - Louis Vuitton Société Européenne'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. Above most other metrics, we think its important to track how fast earnings per share is growing, if at all. If you've also come to that realization, you're in luck, because today you can view this interactive graph of LVMH Moët Hennessy - Louis Vuitton Société Européenne's earnings per share history for free.

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.