Is Compagnie de l'Odet (EPA:ODET) A Risky Investment?

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. Importantly, Compagnie de l'Odet (EPA:ODET) does carry debt. But the real question is whether this debt is making the company risky.

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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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. When we examine debt levels, we first consider both cash and debt levels, together.

See our latest analysis for Compagnie de l'Odet

How Much Debt Does Compagnie de l'Odet Carry?

As you can see below, Compagnie de l'Odet had €6.20b of debt at June 2023, down from €7.76b a year prior. However, because it has a cash reserve of €5.61b, its net debt is less, at about €591.3m.

How Healthy Is Compagnie de l'Odet's Balance Sheet?

We can see from the most recent balance sheet that Compagnie de l'Odet had liabilities of €11.6b falling due within a year, and liabilities of €7.33b due beyond that. Offsetting these obligations, it had cash of €5.61b as well as receivables valued at €5.41b due within 12 months. So it has liabilities totalling €7.94b more than its cash and near-term receivables, combined.

Given this deficit is actually higher than the company's market capitalization of €5.74b, we think shareholders really should watch Compagnie de l'Odet'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 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.

Compagnie de l'Odet has very modest net debt levels, with net debt at just 0.095 times EBITDA. Humorously, it actually received more in interest over the last twelve months than it had to pay. So there's no doubt this company can take on debt as easily as enthusiastic spray-tanners take on an orange hue. Even more impressive was the fact that Compagnie de l'Odet grew its EBIT by 375% over twelve months. If maintained that growth will make the debt even more manageable in the years ahead. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since Compagnie de l'Odet will need earnings to service that debt. So if you're keen to discover more about its earnings, it might be worth checking out this graph of its long term earnings trend.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So we always check how much of that EBIT is translated into free cash flow. Over the last three years, Compagnie de l'Odet actually produced more free cash flow than EBIT. There's nothing better than incoming cash when it comes to staying in your lenders' good graces.

Our View

The good news is that Compagnie de l'Odet's demonstrated ability to cover its interest expense with its EBIT delights us like a fluffy puppy does a toddler. But we must concede we find its level of total liabilities has the opposite effect. All these things considered, it appears that Compagnie de l'Odet 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. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. For instance, we've identified 1 warning sign for Compagnie de l'Odet that 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.