We think Legrand (EPA:LR) can manage its debt with ease

Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett said “volatility is far from synonymous with risk.” 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. Above all, Legrand S.A. (EPA:LR) is in debt. But the more important question is: what risk does this debt create?

Why is debt risky?

Debt and other liabilities become risky for a business when it cannot easily meet those obligations, either with free cash flow or by raising capital at an attractive price. If things go really bad, lenders can take over the business. However, a more common (but still painful) scenario is that it has to raise new equity at a low price, thereby permanently diluting shareholders. That said, the most common situation is when a company manages its debt reasonably well – and to its own benefit. When we think about a company’s use of debt, we first look at cash and debt together.

See our latest analysis for Legrand

How much debt does Legrand carry?

The graph below, which you can click on for more details, shows that Legrand had 5.03 billion euros in debt in December 2021; about the same as the previous year. However, he also had €2.79 billion in cash, so his net debt is €2.24 billion.

ENXTPA: LR Debt to Equity April 25, 2022

How strong is Legrand’s balance sheet?

The latest balance sheet data shows that Legrand had liabilities of 2.59 billion euros due within one year and liabilities of 5.72 billion euros due in the future. In return, it had 2.79 billion euros in cash and 1.00 billion euros in receivables due within 12 months. Thus, its liabilities outweigh the sum of its cash and (short-term) receivables by €4.51 billion.

Given that Legrand has a colossal market cap of €22.6 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.

In order to assess a company’s debt relative to its earnings, we calculate its net debt divided by its earnings before interest, taxes, depreciation and amortization (EBITDA) and its earnings before interest and taxes (EBIT) divided by its expenses. interest (its interest coverage). The advantage of this approach is that we consider both the absolute amount of debt (with net debt to EBITDA) and the actual interest expense associated with that debt (with its interest coverage ratio ).

Legrand’s net debt represents only 1.4 times its EBITDA. And its EBIT covers its interest costs 16.0 times. One could therefore say that he is no more threatened by his debt than an elephant is by a mouse. Another good sign, Legrand was able to increase its EBIT by 26% in twelve months, thus facilitating the repayment of its debt. The balance sheet is clearly the area to focus on when analyzing debt. 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 82% of its EBIT, which is higher than what we would normally expect. This puts him in a very strong position to repay his debt.

Our point of view

Fortunately, Legrand’s impressive interest coverage means it has the upper hand on its debt. And the good news doesn’t stop there, since its conversion of EBIT into free cash flow also confirms this impression! Zooming out, Legrand seems to be using debt quite sensibly; and that gets the green light from us. Although debt carries risks, when used wisely, it can also generate a higher return on equity. Above most other metrics, we think it’s important to track how quickly earnings per share are growing, if at all. If you’ve also achieved this achievement, you’re in luck, because today you can view this interactive graph of Legrand’s earnings per share history for free.

If, after all that, you’re more interested in a fast-growing company with a strong balance sheet, check out our list of cash-neutral growth stocks right away.

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.

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