Arkema (EPA:AKE) Has A Pretty Healthy Balance Sheet

Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk.' So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. Importantly, Arkema S.A. (EPA:AKE) does carry debt. But the real question is whether this debt is making the company risky.

What Risk Does Debt Bring?

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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we examine debt levels, we first consider both cash and debt levels, together.

See our latest analysis for Arkema

What Is Arkema's Net Debt?

You can click the graphic below for the historical numbers, but it shows that as of September 2023 Arkema had €3.62b of debt, an increase on €3.20b, over one year. However, it does have €1.90b in cash offsetting this, leading to net debt of about €1.72b.

A Look At Arkema's Liabilities

Zooming in on the latest balance sheet data, we can see that Arkema had liabilities of €2.20b due within 12 months and liabilities of €4.07b due beyond that. Offsetting these obligations, it had cash of €1.90b as well as receivables valued at €1.70b due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by €2.68b.

While this might seem like a lot, it is not so bad since Arkema has a market capitalization of €7.67b, and so it could probably strengthen its balance sheet by raising capital if it needed to. But we definitely want to keep our eyes open to indications that its debt is bringing too much risk.

In order to size up a company's debt relative to its earnings, we calculate its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and its earnings before interest and tax (EBIT) divided by its interest expense (its interest cover). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

Arkema's net debt is only 1.3 times its EBITDA. And its EBIT easily covers its interest expense, being 12.9 times the size. So we're pretty relaxed about its super-conservative use of debt. Fortunately, Arkema grew its EBIT by 5.3% 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 ultimately the future profitability of the business will decide if Arkema 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. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. Looking at the most recent three years, Arkema recorded free cash flow of 47% of its EBIT, which is weaker than we'd expect. That's not great, when it comes to paying down debt.

Our View

When it comes to the balance sheet, the standout positive for Arkema was the fact that it seems able to cover its interest expense with its EBIT confidently. But the other factors we noted above weren't so encouraging. For instance it seems like it has to struggle a bit to handle its total liabilities. When we consider all the elements mentioned above, it seems to us that Arkema is managing its debt quite well. Having said that, the load is sufficiently heavy that we would recommend any shareholders keep a close eye on it. 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 Arkema that you should be aware of before investing here.

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.