These 4 Measures Indicate That Etablissements Maurel & Prom (EPA:MAU) Is Using Debt Reasonably Well

Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' 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 Etablissements Maurel & Prom S.A. (EPA:MAU) does have debt on its balance sheet. But the real question is whether this debt is making the company risky.

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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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. 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.

See our latest analysis for Etablissements Maurel & Prom

What Is Etablissements Maurel & Prom's Net Debt?

The image below, which you can click on for greater detail, shows that Etablissements Maurel & Prom had debt of US$316.5m at the end of June 2023, a reduction from US$453.4m over a year. However, because it has a cash reserve of US$232.7m, its net debt is less, at about US$83.8m.

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

We can see from the most recent balance sheet that Etablissements Maurel & Prom had liabilities of US$377.2m falling due within a year, and liabilities of US$455.7m due beyond that. Offsetting these obligations, it had cash of US$232.7m as well as receivables valued at US$139.5m due within 12 months. So it has liabilities totalling US$460.7m more than its cash and near-term receivables, combined.

This deficit isn't so bad because Etablissements Maurel & Prom is worth US$1.30b, and thus could probably raise enough capital to shore up 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). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

Etablissements Maurel & Prom has a low net debt to EBITDA ratio of only 0.24. And its EBIT easily covers its interest expense, being 13.3 times the size. So you could argue it is no more threatened by its debt than an elephant is by a mouse. But the bad news is that Etablissements Maurel & Prom has seen its EBIT plunge 20% in the last twelve months. If that rate of decline in earnings continues, the company could find itself in a tight spot. There's no doubt that we learn most about debt from the balance sheet. But it is future earnings, more than anything, that will determine Etablissements Maurel & Prom'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, a company can only pay off debt with cold hard cash, not accounting profits. So we always check how much of that EBIT is translated into free cash flow. During the last three years, Etablissements Maurel & Prom produced sturdy free cash flow equating to 57% of its EBIT, about what we'd expect. This free cash flow puts the company in a good position to pay down debt, when appropriate.

Our View

Both Etablissements Maurel & Prom's ability to to cover its interest expense with its EBIT and its net debt to EBITDA gave us comfort that it can handle its debt. In contrast, our confidence was undermined by its apparent struggle to grow its EBIT. When we consider all the factors mentioned above, we do feel a bit cautious about Etablissements Maurel & Prom's use of debt. While we appreciate debt can enhance returns on equity, we'd suggest that shareholders keep close watch on its debt levels, lest they increase. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. We've identified 2 warning signs with Etablissements Maurel & Prom , and understanding them should be part of your investment process.

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.