These 4 Measures Indicate That Eurasia Fonciere Investissements Société Anonyme (EPA:EFI) Is Using Debt Extensively

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.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. As with many other companies Eurasia Fonciere Investissements Société Anonyme (EPA:EFI) makes use of debt. But should shareholders be worried about its use of debt?

Why Does Debt Bring Risk?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

See our latest analysis for Eurasia Fonciere Investissements Société Anonyme

What Is Eurasia Fonciere Investissements Société Anonyme's Debt?

The image below, which you can click on for greater detail, shows that Eurasia Fonciere Investissements Société Anonyme had debt of €9.91m at the end of June 2021, a reduction from €10.9m over a year. However, it also had €917.0k in cash, and so its net debt is €8.99m.

A Look At Eurasia Fonciere Investissements Société Anonyme's Liabilities

According to the last reported balance sheet, Eurasia Fonciere Investissements Société Anonyme had liabilities of €8.91m due within 12 months, and liabilities of €16.7m due beyond 12 months. Offsetting these obligations, it had cash of €917.0k as well as receivables valued at €17.1m due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by €7.56m.

While this might seem like a lot, it is not so bad since Eurasia Fonciere Investissements Société Anonyme has a market capitalization of €29.8m, 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.

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). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

We'd say that Eurasia Fonciere Investissements Société Anonyme's moderate net debt to EBITDA ratio ( being 2.5), indicates prudence when it comes to debt. And its commanding EBIT of 315 times its interest expense, implies the debt load is as light as a peacock feather. Importantly, Eurasia Fonciere Investissements Société Anonyme's EBIT fell a jaw-dropping 38% in the last twelve months. If that decline continues then paying off debt will be harder than selling foie gras at a vegan convention. The balance sheet is clearly the area to focus on when you are analysing debt. But you can't view debt in total isolation; since Eurasia Fonciere Investissements Société Anonyme will need earnings to service that debt. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. So the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. In the last two years, Eurasia Fonciere Investissements Société Anonyme's free cash flow amounted to 27% of its EBIT, less than we'd expect. That's not great, when it comes to paying down debt.

Our View

Neither Eurasia Fonciere Investissements Société Anonyme's ability to grow its EBIT nor its conversion of EBIT to free cash flow gave us confidence in its ability to take on more debt. But its interest cover tells a very different story, and suggests some resilience. When we consider all the factors discussed, it seems to us that Eurasia Fonciere Investissements Société Anonyme is taking some risks with its use of debt. While that debt can boost returns, we think the company has enough leverage now. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. Be aware that Eurasia Fonciere Investissements Société Anonyme is showing 4 warning signs in our investment analysis , and 2 of those are a bit concerning...

If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.

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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.