Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital. So it seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. Importantly, Publicis Groupe S.A. (EPA:PUB) does carry debt. But the more important question is: how much risk is that debt creating?
Why Does Debt Bring Risk?
Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. If things get really bad, the lenders can take control of the business. 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. 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.
What Is Publicis Groupe's Debt?
The chart below, which you can click on for greater detail, shows that Publicis Groupe had €4.83b in debt in June 2019; about the same as the year before. On the flip side, it has €4.74b in cash leading to net debt of about €88.0m.
How Healthy Is Publicis Groupe's Balance Sheet?
We can see from the most recent balance sheet that Publicis Groupe had liabilities of €14.8b falling due within a year, and liabilities of €7.04b due beyond that. Offsetting these obligations, it had cash of €4.74b as well as receivables valued at €10.5b due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by €6.69b.
This deficit is considerable relative to its very significant market capitalization of €9.28b, so it does suggest shareholders should keep an eye on Publicis Groupe's use of debt. This suggests shareholders would heavily diluted if the company needed to shore up its balance sheet in a hurry. But either way, Publicis Groupe has virtually no net debt, so it's fair to say it does not have a heavy debt load!
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). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.
With debt at a measly 0.049 times EBITDA and EBIT covering interest a whopping 35.2 times, it's clear that Publicis Groupe is not a desperate borrower. Indeed relative to its earnings its debt load seems light as a feather. Fortunately, Publicis Groupe grew its EBIT by 7.2% in the last year, making that debt load look even more manageable. There's no doubt that we learn most about debt from the balance sheet. But ultimately the future profitability of the business will decide if Publicis Groupe can strengthen its balance sheet over time. 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 company can only pay off debt with cold hard cash, not accounting profits. So it's worth checking how much of that EBIT is backed by free cash flow. Over the last three years, Publicis Groupe recorded free cash flow worth a fulsome 95% of its EBIT, which is stronger than we'd usually expect. That puts it in a very strong position to pay down debt.
The good news is that Publicis Groupe's demonstrated ability to cover its interest expense with its EBIT delights us like a fluffy puppy does a toddler. But, on a more sombre note, we are a little concerned by its level of total liabilities. When we consider the range of factors above, it looks like Publicis Groupe is pretty sensible with its use of debt. While that brings some risk, it can also enhance returns for shareholders. Given Publicis Groupe has a strong balance sheet is profitable and pays a dividend, it would be good to know how fast its dividends are growing, if at all. You can find out instantly by clicking this link.
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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