We Think ERAMET (EPA:ERA) Can Stay On Top Of Its Debt

Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' 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 ERAMET S.A. (EPA:ERA) does have debt on its balance sheet. But should shareholders be worried about its use of debt?

What Risk Does Debt Bring?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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 think about a company's use of debt, we first look at cash and debt together.

View our latest analysis for ERAMET

What Is ERAMET's Net Debt?

As you can see below, ERAMET had €1.89b of debt at December 2022, down from €2.03b a year prior. However, it does have €1.67b in cash offsetting this, leading to net debt of about €220.0m.

How Healthy Is ERAMET's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that ERAMET had liabilities of €2.52b due within 12 months and liabilities of €2.40b due beyond that. On the other hand, it had cash of €1.67b and €802.0m worth of receivables due within a year. So it has liabilities totalling €2.44b more than its cash and near-term receivables, combined.

Given this deficit is actually higher than the company's market capitalization of €2.33b, we think shareholders really should watch ERAMET's debt levels, like a parent watching their child ride a bike for the first time. Hypothetically, extremely heavy dilution would be required if the company were forced to pay down its liabilities by raising capital at the current share price.

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.

ERAMET's net debt is only 0.15 times its EBITDA. And its EBIT covers its interest expense a whopping 12.8 times over. So you could argue it is no more threatened by its debt than an elephant is by a mouse. On top of that, ERAMET grew its EBIT by 64% over the last twelve months, and that growth will make it easier to handle its 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 ERAMET'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 business needs free cash flow to pay off debt; accounting profits just don't cut it. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. In the last three years, ERAMET's free cash flow amounted to 35% of its EBIT, less than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.

Our View

ERAMET's interest cover was a real positive on this analysis, as was its EBIT growth rate. On the other hand, its level of total liabilities makes us a little less comfortable about its debt. When we consider all the elements mentioned above, it seems to us that ERAMET 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. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. For instance, we've identified 2 warning signs for ERAMET (1 is a bit concerning) you should be aware of.

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

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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.