These 4 Measures Indicate That EssilorLuxottica Société anonyme (EPA:EL) Is Using Debt Reasonably Well

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 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. If things get really bad, the lenders can take control of the business. 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. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. When we examine debt levels, we first consider both cash and debt levels, 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 €8.42b of debt at December 2023, down from €9.02b a year prior. However, it does have €2.56b in cash offsetting this, leading to net debt of about €5.86b.

How Strong Is EssilorLuxottica Société anonyme's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that EssilorLuxottica Société anonyme had liabilities of €9.74b due within 12 months and liabilities of €11.9b due beyond that. On the other hand, it had cash of €2.56b and €3.55b worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by €15.5b.

Since publicly traded EssilorLuxottica Société anonyme shares are worth a very impressive total of €94.3b, it seems unlikely that this level of liabilities would be a major threat. Having said that, it's clear that we should continue to monitor its balance sheet, lest it change for the worse.

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.

EssilorLuxottica Société anonyme's net debt is only 1.1 times its EBITDA. And its EBIT easily covers its interest expense, being 29.5 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 4.1% 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 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, while the tax-man may adore accounting profits, lenders only accept cold hard cash. 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. 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. It's also worth noting that EssilorLuxottica Société anonyme is in the Medical Equipment industry, which is often considered to be quite defensive. 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. 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.

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.

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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.