Constellium (NYSE:CSTM) Has A Somewhat Strained Balance Sheet

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 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. We note that Constellium SE (NYSE:CSTM) does have debt on its balance sheet. But the more important question is: how much risk is that debt creating?

When Is Debt A Problem?

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. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

Check out our latest analysis for Constellium

What Is Constellium's Net Debt?

The image below, which you can click on for greater detail, shows that Constellium had debt of €1.68b at the end of September 2024, a reduction from €1.76b over a year. However, it also had €152.0m in cash, and so its net debt is €1.53b.

A Look At Constellium's Liabilities

According to the last reported balance sheet, Constellium had liabilities of €1.50b due within 12 months, and liabilities of €2.35b due beyond 12 months. On the other hand, it had cash of €152.0m and €591.0m worth of receivables due within a year. So it has liabilities totalling €3.10b more than its cash and near-term receivables, combined.

This deficit casts a shadow over the €1.59b company, like a colossus towering over mere mortals. So we'd watch its balance sheet closely, without a doubt. After all, Constellium would likely require a major re-capitalisation if it had to pay its creditors today.

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.

Constellium's debt is 3.0 times its EBITDA, and its EBIT cover its interest expense 2.8 times over. Taken together this implies that, while we wouldn't want to see debt levels rise, we think it can handle its current leverage. Given the debt load, it's hardly ideal that Constellium's EBIT was pretty flat over the last twelve months. 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 Constellium'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 the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. Looking at the most recent three years, Constellium recorded free cash flow of 48% of its EBIT, which is weaker than we'd expect. That's not great, when it comes to paying down debt.

Our View

We'd go so far as to say Constellium's level of total liabilities was disappointing. But at least its conversion of EBIT to free cash flow is not so bad. Overall, it seems to us that Constellium's balance sheet is really quite a risk to the business. So we're almost as wary of this stock as a hungry kitten is about falling into its owner's fish pond: once bitten, twice shy, as they say. 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 Constellium (1 is a bit concerning) you should be aware of.

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.