L'Oréal (EPA:OR) Has A Rock Solid Balance Sheet

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. We note that L'Oréal S.A. (EPA:OR) does have debt on its balance sheet. But the more important question is: how much risk is that debt creating?

When Is Debt Dangerous?

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. 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, plenty of companies use debt to fund growth, without any negative consequences. When we examine debt levels, we first consider both cash and debt levels, together.

Check out our latest analysis for L'Oréal

How Much Debt Does L'Oréal Carry?

You can click the graphic below for the historical numbers, but it shows that L'Oréal had €872.5m of debt in June 2021, down from €2.42b, one year before. However, it does have €4.82b in cash offsetting this, leading to net cash of €3.95b.

How Healthy Is L'Oréal's Balance Sheet?

According to the last reported balance sheet, L'Oréal had liabilities of €11.3b due within 12 months, and liabilities of €2.99b due beyond 12 months. Offsetting these obligations, it had cash of €4.82b as well as receivables valued at €4.12b due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by €5.37b.

Since publicly traded L'Oréal shares are worth a very impressive total of €223.6b, 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. 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 it is future earnings, more than anything, that will determine L'Oréal's ability to maintain a healthy balance sheet going forward. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. 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. Over the last three years, L'Oréal recorded free cash flow worth a fulsome 93% of its EBIT, which is stronger than we'd usually 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. The cherry on top was that in converted 93% of that EBIT to free cash flow, bringing in €6.3b. So is L'Oréal's debt a risk? It doesn't seem so to us. 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.