Does EssilorLuxottica Société anonyme (EPA:EL) Have A Healthy Balance Sheet?

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 should shareholders be worried about its use of debt?

What Risk Does Debt Bring?

Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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, 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.

See our latest analysis for EssilorLuxottica Société anonyme

How Much Debt Does EssilorLuxottica Société anonyme Carry?

As you can see below, EssilorLuxottica Société anonyme had €8.57b of debt at June 2023, down from €11.0b a year prior. On the flip side, it has €1.70b in cash leading to net debt of about €6.88b.

A Look At EssilorLuxottica Société anonyme's Liabilities

We can see from the most recent balance sheet that EssilorLuxottica Société anonyme had liabilities of €9.89b falling due within a year, and liabilities of €12.0b due beyond that. On the other hand, it had cash of €1.70b and €3.56b worth of receivables due within a year. So it has liabilities totalling €16.6b more than its cash and near-term receivables, combined.

While this might seem like a lot, it is not so bad since EssilorLuxottica Société anonyme has a huge market capitalization of €76.0b, and so it could probably strengthen its balance sheet by raising capital if it needed to. However, it is still worthwhile taking a close look at its ability to pay off debt.

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). The advantage of this approach is that we take into account both the absolute quantum of debt (with net debt to EBITDA) and the actual interest expenses associated with that debt (with its interest cover ratio).

EssilorLuxottica Société anonyme's net debt is only 1.3 times its EBITDA. And its EBIT easily covers its interest expense, being 27.1 times the size. So you could argue it is no more threatened by its debt than an elephant is by a mouse. Another good sign is that EssilorLuxottica Société anonyme has been able to increase its EBIT by 25% in twelve months, making it easier to pay down 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 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 business needs free cash flow to pay off debt; accounting profits just don't cut it. So the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. Over the last three years, EssilorLuxottica Société anonyme actually produced more free cash flow than EBIT. 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! We would also note that Medical Equipment industry companies like EssilorLuxottica Société anonyme commonly do use debt without problems. Considering this range of factors, it seems to us that EssilorLuxottica Société anonyme is quite prudent with its debt, and the risks seem well managed. So we're not worried about the use of a little leverage on the balance sheet. 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.

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

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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.