Financière de l'Odet (EPA:ODET) Has A Pretty Healthy Balance Sheet

David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the 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 Financière de l'Odet SA (EPA:ODET) does use debt in its business. But the real question is whether this debt is making the company risky.

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. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. The first step when considering a company's debt levels is to consider its cash and debt together.

See our latest analysis for Financière de l'Odet

How Much Debt Does Financière de l'Odet Carry?

The image below, which you can click on for greater detail, shows that Financière de l'Odet had debt of €11.4b at the end of December 2020, a reduction from €11.9b over a year. However, because it has a cash reserve of €2.48b, its net debt is less, at about €8.89b.

How Strong Is Financière de l'Odet's Balance Sheet?

According to the last reported balance sheet, Financière de l'Odet had liabilities of €17.3b due within 12 months, and liabilities of €14.6b due beyond 12 months. Offsetting these obligations, it had cash of €2.48b as well as receivables valued at €6.69b due within 12 months. So it has liabilities totalling €22.7b more than its cash and near-term receivables, combined.

The deficiency here weighs heavily on the €4.35b company itself, as if a child were struggling under the weight of an enormous back-pack full of books, his sports gear, and a trumpet. So we'd watch its balance sheet closely, without a doubt. After all, Financière de l'Odet would likely require a major re-capitalisation if it had to pay its creditors today.

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.

Financière de l'Odet has net debt to EBITDA of 3.7 suggesting it uses a fair bit of leverage to boost returns. But the high interest coverage of 9.4 suggests it can easily service that debt. Also relevant is that Financière de l'Odet has grown its EBIT by a very respectable 27% in the last year, thus enhancing its ability to pay down debt. 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 Financière 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 it's worth checking how much of that EBIT is backed by free cash flow. Over the last three years, Financière de l'Odet recorded free cash flow worth a fulsome 92% of its EBIT, which is stronger than we'd usually expect. That puts it in a very strong position to pay down debt.

Our View

Based on what we've seen Financière de l'Odet is not finding it easy, given its level of total liabilities, but the other factors we considered give us cause to be optimistic. In particular, we are dazzled with its conversion of EBIT to free cash flow. When we consider all the factors mentioned above, we do feel a bit cautious about Financière de l'Odet's use of debt. While debt does have its upside in higher potential returns, we think shareholders should definitely consider how debt levels might make the stock more risky. 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. These risks can be hard to spot. Every company has them, and we've spotted 3 warning signs for Financière de l'Odet (of which 2 don't sit too well with us!) you should know about.

When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.

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