David Iben said it well when he said: “Volatility is not a risk that interests us. What matters to us is to avoid the permanent loss of capital. So it may be obvious that you need to take debt into account when thinking about the risk of a given stock, because too much debt can sink a business. Like many other companies Legrand S.A. (EPA:LR) uses debt. But should shareholders worry about its use of debt?
What risk does debt carry?
Generally speaking, debt only becomes a real problem when a company cannot easily repay it, either by raising capital or with its own cash flow. In the worst case, a company can go bankrupt if it cannot pay its creditors. However, a more usual (but still expensive) situation is when a company has to dilute shareholders at a cheap share price just to keep debt under control. Of course, many companies use debt to finance their growth, without any negative consequences. When we look at debt levels, we first consider cash and debt levels, together.
See our latest analysis for Legrand
What is Legrand’s net debt?
You can click on the chart below for historical figures, but it shows Legrand had €4.85 billion in debt in September 2021, up from €5.14 billion a year earlier. However, because he has a cash reserve of 2.67 billion euros, his net debt is less, at around 2.17 billion euros.
How strong is Legrand’s balance sheet?
According to the last published balance sheet, Legrand had liabilities of 2.98 billion euros within 12 months and liabilities of 5.12 billion euros beyond 12 months. On the other hand, it had cash of 2.67 billion euros and 863.8 million euros in receivables at less than one year. Thus, its liabilities outweigh the sum of its cash and (short-term) receivables by €4.56 billion.
Given that Legrand has a colossal market cap of €25.3 billion, it’s hard to believe that these liabilities pose a threat. That said, it is clear that we must continue to monitor its record, lest it deteriorate.
We measure a company’s leverage against its earning power by looking at its net debt divided by its earnings before interest, taxes, depreciation and amortization (EBITDA) and calculating how easily its earnings before interest and taxes (EBIT ) covers its interest charge (interest coverage). Thus, we consider debt to earnings with and without amortization and depreciation expense.
Legrand has a low net debt to EBITDA ratio of just 1.4. And its EBIT covers its interest charges 15.1 times. So we’re pretty relaxed about his super-conservative use of debt. Another good sign, Legrand was able to increase its EBIT by 24% in twelve months, thus facilitating the repayment of its debt. When analyzing debt levels, the balance sheet is the obvious starting point. But it is future earnings, more than anything, that will determine Legrand’s ability to maintain a healthy balance sheet in the future. So if you want to see what the professionals think, you might find this free analyst earnings forecast report interesting.
But our last consideration is also important, because a company cannot pay debt with paper profits; he needs cash. We therefore always check how much of this EBIT is converted into free cash flow. Over the past three years, Legrand has recorded free cash flow worth 85% of its EBIT, which is higher than what we would usually expect. This positions him well to pay off debt if desired.
Our point of view
Legrand’s interest coverage suggests he can manage his debt as easily as Cristiano Ronaldo could score a goal against an Under-14 keeper. And this is only the beginning of good news since its conversion of EBIT into free cash flow is also very pleasing. Overall, we think Legrand’s use of debt seems entirely reasonable and we’re not worried about that. Although debt carries risks, when used wisely, it can also generate a higher return on equity. The balance sheet is clearly the area to focus on when analyzing debt. However, not all investment risks reside on the balance sheet, far from it. For example – Legrand has 1 warning sign we think you should know.
If, after all that, you’re more interested in a fast-growing company with a strong balance sheet, check out our list of cash-flowing growth stocks without further ado.
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This Simply Wall St article is general in nature. We provide commentary based on historical data and analyst forecasts only using unbiased methodology and our articles are not intended to be financial advice. It is not a recommendation to buy or sell stocks and does not take into account your objectives or financial situation. Our goal is to bring you targeted long-term analysis based on fundamental data. Note that our analysis may not take into account the latest announcements from price-sensitive companies or qualitative materials. Simply Wall St has no position in the stocks mentioned.