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Does Compagnie Générale des Établissements Michelin's (EPA:ML) Debt Level Pose A Problem?

Simply Wall St

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Investors seeking to preserve capital in a volatile environment might consider large-cap stocks such as Compagnie Générale des Établissements Michelin (EPA:ML) a safer option. Risk-averse investors who are attracted to diversified streams of revenue and strong capital returns tend to seek out these large companies. However, the key to extending previous success is in the health of the company’s financials. I will provide an overview of Compagnie Générale des Établissements Michelin’s financial liquidity and leverage to give you an idea of Compagnie Générale des Établissements Michelin’s position to take advantage of potential acquisitions or comfortably endure future downturns. Remember this is a very top-level look that focuses exclusively on financial health, so I recommend a deeper analysis into ML here.

View our latest analysis for Compagnie Générale des Établissements Michelin

ML’s Debt (And Cash Flows)

ML has built up its total debt levels in the last twelve months, from €2.9b to €6.2b – this includes long-term debt. With this rise in debt, ML's cash and short-term investments stands at €2.3b to keep the business going. On top of this, ML has produced €2.8b in operating cash flow in the last twelve months, resulting in an operating cash to total debt ratio of 46%, meaning that ML’s operating cash is sufficient to cover its debt.

Can ML meet its short-term obligations with the cash in hand?

With current liabilities at €6.8b, the company has maintained a safe level of current assets to meet its obligations, with the current ratio last standing at 1.66x. The current ratio is calculated by dividing current assets by current liabilities. Generally, for Auto Components companies, this is a reasonable ratio since there's a sufficient cash cushion without leaving too much capital idle or in low-earning investments.

ENXTPA:ML Historical Debt, May 7th 2019

Is ML’s debt level acceptable?

With debt reaching 51% of equity, ML may be thought of as relatively highly levered. This isn’t uncommon for large companies because interest payments on debt are tax deductible, meaning debt can be a cheaper source of capital than equity. Accordingly, large companies often have an advantage over small-caps through lower cost of capital due to cheaper financing. We can assess the sustainability of ML’s debt levels to the test by looking at how well interest payments are covered by earnings. Preferably, earnings before interest and tax (EBIT) should be at least three times as large as net interest. For ML, the ratio of 13.69x suggests that interest is comfortably covered. Large-cap investments like ML are often believed to be a safe investment due to their ability to pump out ample earnings multiple times its interest payments.

Next Steps:

ML’s high cash coverage means that, although its debt levels are high, the company is able to utilise its borrowings efficiently in order to generate cash flow. Since there is also no concerns around ML's liquidity needs, this may be its optimal capital structure for the time being. I admit this is a fairly basic analysis for ML's financial health. Other important fundamentals need to be considered alongside. I recommend you continue to research Compagnie Générale des Établissements Michelin to get a more holistic view of the large-cap by looking at:

  1. Future Outlook: What are well-informed industry analysts predicting for ML’s future growth? Take a look at our free research report of analyst consensus for ML’s outlook.
  2. Valuation: What is ML worth today? Is the stock undervalued, even when its growth outlook is factored into its intrinsic value? The intrinsic value infographic in our free research report helps visualize whether ML is currently mispriced by the market.
  3. Other High-Performing Stocks: Are there other stocks that provide better prospects with proven track records? Explore our free list of these great stocks here.

We aim to bring you long-term focused research analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material.

If you spot an error that warrants correction, please contact the editor at editorial-team@simplywallst.com. This article by Simply Wall St is general in nature. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. Simply Wall St has no position in the stocks mentioned. Thank you for reading.