L'Air Liquide (EPA:AI) Seems To Use Debt Quite Sensibly

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.' 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 can see that L'Air Liquide S.A. (EPA:AI) does use debt in its business. But is this debt a concern to shareholders?

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. 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. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. The first step when considering a company's debt levels is to consider its cash and debt together.

View our latest analysis for L'Air Liquide

How Much Debt Does L'Air Liquide Carry?

The chart below, which you can click on for greater detail, shows that L'Air Liquide had €11.9b in debt in June 2024; about the same as the year before. However, it does have €1.79b in cash offsetting this, leading to net debt of about €10.2b.

How Healthy Is L'Air Liquide's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that L'Air Liquide had liabilities of €10.4b due within 12 months and liabilities of €14.1b due beyond that. Offsetting these obligations, it had cash of €1.79b as well as receivables valued at €3.15b due within 12 months. So its liabilities total €19.5b more than the combination of its cash and short-term receivables.

This deficit isn't so bad because L'Air Liquide is worth a massive €92.0b, and thus could probably raise enough capital to shore up its balance sheet, if the need arose. However, it is still worthwhile taking a close look at its ability to pay off debt.

We use two main ratios to inform us about debt levels relative to earnings. The first is net debt divided by earnings before interest, tax, depreciation, and amortization (EBITDA), while the second is how many times its earnings before interest and tax (EBIT) covers its interest expense (or its interest cover, for short). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

L'Air Liquide has a low net debt to EBITDA ratio of only 1.4. And its EBIT easily covers its interest expense, being 15.5 times the size. So we're pretty relaxed about its super-conservative use of debt. Fortunately, L'Air Liquide grew its EBIT by 2.1% in the last year, making that debt load look even more manageable. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine L'Air Liquide'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 company can only pay off debt with cold hard cash, not accounting profits. So we always check how much of that EBIT is translated into free cash flow. During the last three years, L'Air Liquide produced sturdy free cash flow equating to 61% of its EBIT, about what we'd expect. This cold hard cash means it can reduce its debt when it wants to.

Our View

Happily, L'Air Liquide's impressive interest cover implies it has the upper hand on its debt. And its conversion of EBIT to free cash flow is good too. All these things considered, it appears that L'Air Liquide can comfortably handle its current debt levels. Of course, while this leverage can enhance returns on equity, it does bring more risk, so it's worth keeping an eye on this one. Over time, share prices tend to follow earnings per share, so if you're interested in L'Air Liquide, you may well want to click here to check an interactive graph of its earnings per share history.

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.