Does Etablissements Maurel & Prom (EPA:MAU) Have A Healthy Balance Sheet?

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. We note that Etablissements Maurel & Prom S.A. (EPA:MAU) does have debt on its balance sheet. But should shareholders be worried about its use of debt?

Why Does Debt Bring Risk?

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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. When we think about a company's use of debt, we first look at cash and debt together.

Check out our latest analysis for Etablissements Maurel & Prom

What Is Etablissements Maurel & Prom's Debt?

You can click the graphic below for the historical numbers, but it shows that Etablissements Maurel & Prom had US$536.1m of debt in December 2021, down from US$622.6m, one year before. However, because it has a cash reserve of US$195.7m, its net debt is less, at about US$340.4m.

How Healthy Is Etablissements Maurel & Prom's Balance Sheet?

We can see from the most recent balance sheet that Etablissements Maurel & Prom had liabilities of US$421.0m falling due within a year, and liabilities of US$576.5m due beyond that. Offsetting these obligations, it had cash of US$195.7m as well as receivables valued at US$180.0m due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by US$621.9m.

This is a mountain of leverage relative to its market capitalization of US$981.6m. 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.

Etablissements Maurel & Prom's net debt is only 1.3 times its EBITDA. And its EBIT easily covers its interest expense, being 12.2 times the size. So we're pretty relaxed about its super-conservative use of debt. It was also good to see that despite losing money on the EBIT line last year, Etablissements Maurel & Prom turned things around in the last 12 months, delivering and EBIT of US$173m. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Etablissements Maurel & Prom 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 is important to check how much of its earnings before interest and tax (EBIT) converts to actual free cash flow. Over the most recent year, Etablissements Maurel & Prom recorded free cash flow worth 67% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This free cash flow puts the company in a good position to pay down debt, when appropriate.

Our View

When it comes to the balance sheet, the standout positive for Etablissements Maurel & Prom was the fact that it seems able to cover its interest expense with its EBIT confidently. But the other factors we noted above weren't so encouraging. For example, its level of total liabilities makes us a little nervous about its debt. When we consider all the elements mentioned above, it seems to us that Etablissements Maurel & Prom is managing its debt quite well. Having said that, the load is sufficiently heavy that we would recommend any shareholders keep a close eye on it. 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. We've identified 3 warning signs with Etablissements Maurel & Prom (at least 1 which can't be ignored) , 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.