Is L'Oréal (EPA:OR) Using Too Much Debt?

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 L'Oréal S.A. (EPA:OR) does have debt on its balance sheet. But should shareholders be worried about its use of debt?

When Is Debt A Problem?

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, debt can be an important tool in businesses, particularly capital heavy businesses. When we examine debt levels, we first consider both cash and debt levels, together.

See our latest analysis for L'Oréal

What Is L'Oréal's Debt?

As you can see below, L'Oréal had €872.5m of debt at June 2021, down from €2.42b a year prior. However, its balance sheet shows it holds €4.82b in cash, so it actually has €3.95b net cash.

How Strong Is L'Oréal's Balance Sheet?

The latest balance sheet data shows that L'Oréal had liabilities of €11.3b due within a year, and liabilities of €2.99b falling due after that. On the other hand, it had cash of €4.82b and €4.12b worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by €5.37b.

Given L'Oréal has a humongous market capitalization of €219.2b, it's hard to believe these liabilities pose much threat. Having said that, it's clear that we should continue to monitor its balance sheet, lest it change for the worse. While it does have liabilities worth noting, L'Oréal also has more cash than debt, so we're pretty confident it can manage its debt safely.

Also good is that L'Oréal grew its EBIT at 16% over the last year, further increasing its ability to manage debt. 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 L'Oréal 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, while the tax-man may adore accounting profits, lenders only accept cold hard cash. L'Oréal may have net cash on the balance sheet, but it is still interesting to look at how well the business converts its earnings before interest and tax (EBIT) to free cash flow, because that will influence both its need for, and its capacity to manage debt. During the last three years, L'Oréal generated free cash flow amounting to a very robust 93% of its EBIT, more than we'd expect. That puts it in a very strong position to pay down debt.

Summing up

We could understand if investors are concerned about L'Oréal's liabilities, but we can be reassured by the fact it has has net cash of €3.95b. And it impressed us with free cash flow of €6.3b, being 93% of its EBIT. So we don't think L'Oréal's use of debt is risky. 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 L'Oréal'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.
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