We Think Etablissements Maurel & Prom (EPA:MAU) Can Stay On Top Of Its Debt

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.' So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. 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. If things get really bad, the lenders can take control of the business. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. Of course, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

Check out our latest analysis for Etablissements Maurel & Prom

How Much Debt Does Etablissements Maurel & Prom Carry?

As you can see below, Etablissements Maurel & Prom had US$316.5m of debt at June 2023, down from US$453.4m a year prior. However, it does have US$232.7m in cash offsetting this, leading to net debt of about US$83.8m.

A Look At Etablissements Maurel & Prom's Liabilities

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 its liabilities outweigh the sum of its cash and (near-term) receivables by US$460.7m.

This deficit isn't so bad because Etablissements Maurel & Prom is worth US$961.8m, 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's net debt is only 0.24 times its EBITDA. 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. On the other hand, Etablissements Maurel & Prom's EBIT dived 20%, over the last year. We think hat kind of performance, if repeated frequently, could well lead to difficulties for the stock. 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 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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So we clearly need to look at whether that EBIT is leading to corresponding 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

Etablissements Maurel & Prom's interest cover was a real positive on this analysis, as was its net debt to EBITDA. But truth be told its EBIT growth rate had us nibbling our nails. 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. 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. Be aware that Etablissements Maurel & Prom is showing 4 warning signs in our investment analysis , and 1 of those is concerning...

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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

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.