Is EssilorLuxottica Société anonyme (EPA:EL) Using Too Much Debt?

Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' 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. Importantly, EssilorLuxottica Société anonyme (EPA:EL) does carry debt. 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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. 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 step when considering a company's debt levels is to consider its cash and debt together.

Check out our latest analysis for EssilorLuxottica Société anonyme

What Is EssilorLuxottica Société anonyme's Debt?

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

How Healthy Is EssilorLuxottica Société anonyme's Balance Sheet?

We can see from the most recent balance sheet that EssilorLuxottica Société anonyme had liabilities of €11.4b falling due within a year, and liabilities of €10.5b due beyond that. On the other hand, it had cash of €2.17b and €3.95b worth of receivables due within a year. So its liabilities total €15.7b more than the combination of its cash and short-term receivables.

Given EssilorLuxottica Société anonyme has a humongous market capitalization of €92.7b, it's hard to believe these liabilities pose much threat. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time.

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 1.1 times its EBITDA. And its EBIT covers its interest expense a whopping 26.7 times over. So we're pretty relaxed about its super-conservative use of debt. The good news is that EssilorLuxottica Société anonyme has increased its EBIT by 5.4% over twelve months, which should ease any concerns about debt repayment. 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 EssilorLuxottica Société anonyme'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 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. Happily for any shareholders, EssilorLuxottica Société anonyme actually produced more free cash flow than EBIT over the last three years. That sort of strong cash generation warms our hearts like a puppy in a bumblebee suit.

Our View

EssilorLuxottica Société anonyme's interest cover suggests it can handle its debt as easily as Cristiano Ronaldo could score a goal against an under 14's goalkeeper. 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. Looking at the bigger picture, we think EssilorLuxottica Société anonyme's use of debt seems quite reasonable and we're not concerned about it. After all, sensible leverage can boost returns on equity. 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. For example, we've discovered 1 warning sign for EssilorLuxottica Société anonyme that you should be aware of before investing here.

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

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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.