Here's Why EssilorLuxottica Société anonyme (EPA:EL) Can Manage Its Debt Responsibly

David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the permanent loss of capital.' 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 EssilorLuxottica Société anonyme (EPA:EL) 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 common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. When we think about a company's use of debt, we first look at cash and debt together.

View our latest analysis for EssilorLuxottica Société anonyme

What Is EssilorLuxottica Société anonyme's Net Debt?

The chart below, which you can click on for greater detail, shows that EssilorLuxottica Société anonyme had €8.41b in debt in June 2024; about the same as the year before. On the flip side, it has €2.17b in cash leading to net debt of about €6.25b.

A Look At EssilorLuxottica Société anonyme's Liabilities

Zooming in on the latest balance sheet data, we can see that EssilorLuxottica Société anonyme had liabilities of €11.4b due within 12 months and liabilities of €10.5b due beyond that. Offsetting this, it had €2.17b in cash and €3.95b in receivables that were due within 12 months. So its liabilities total €15.7b more than the combination of its cash and short-term receivables.

Of course, EssilorLuxottica Société anonyme has a titanic market capitalization of €107.1b, so these liabilities are probably manageable. But there are sufficient liabilities that we would certainly recommend shareholders continue to monitor the balance sheet, going forward.

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). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

EssilorLuxottica Société anonyme has a low net debt to EBITDA ratio of only 1.1. And its EBIT easily covers its interest expense, being 26.7 times the size. So you could argue it is no more threatened by its debt than an elephant is by a mouse. Fortunately, EssilorLuxottica Société anonyme grew its EBIT by 5.4% in the last year, making that debt load look even more manageable. There's no doubt that we learn most about debt from the balance sheet. But ultimately the future profitability of the business will decide if EssilorLuxottica Société anonyme 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, a company can only pay off debt with cold hard cash, not accounting profits. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. Over the last three years, EssilorLuxottica Société anonyme actually produced more free cash flow than EBIT. There's nothing better than incoming cash when it comes to staying in your lenders' good graces.

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 that's just the beginning of the good news since its conversion of EBIT to free cash flow is also very heartening. We would also note that Medical Equipment industry companies like EssilorLuxottica Société anonyme commonly do use debt without problems. Zooming out, EssilorLuxottica Société anonyme seems to use debt quite reasonably; and that gets the nod from us. After all, sensible leverage can boost returns 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 EssilorLuxottica Société anonyme's earnings per share history for free.

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.