L’Occitane International (HKG:973) could easily take on more debt

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Howard Marks said it well when he said that, rather than worrying about stock price volatility, “the possibility of permanent loss is the risk I worry about…and that every practical investor that I know is worried”. 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 L’Occitane International SA (HKG:973) uses debt. But should shareholders worry about its use of debt?

What risk does debt carry?

Debt helps a business until the business struggles to pay it back, either with new capital or with free cash flow. Ultimately, if the company cannot meet its legal debt repayment obligations, shareholders could walk away with nothing. Although not too common, we often see companies in debt permanently diluting their shareholders because lenders force them to raise capital at a ridiculous price. By replacing dilution, however, debt can be a great tool for companies that need capital to invest in growth at high rates of return. When we look at debt levels, we first consider cash and debt levels, together.

Check out our latest review for L’Occitane International

What is L’Occitane International’s debt?

As you can see below, L’Occitane International had 331.5 million euros in debt in September 2021, compared to 525.9 million euros the previous year. However, he has €181.7m in cash offsetting this, resulting in a net debt of around €149.9m.

SEHK: 973 Historical Debt to Equity March 4, 2022

How strong is L’Occitane International’s balance sheet?

The latest balance sheet data shows that L’Occitane International had liabilities of 739.7 million euros due within one year and liabilities of 412.9 million euros due in the future. On the other hand, it had €181.7 million in cash and €208.1 million in receivables at less than one year. Its liabilities therefore total €762.8 million more than the combination of its cash and short-term receivables.

Given that L’Occitane International has a market capitalization of 4.18 billion euros, it’s hard to believe that these liabilities pose a big threat. That said, it is clear that we must continue to monitor its record, lest it deteriorate.

We use two main ratios to inform us about debt to earnings levels. The first is net debt divided by earnings before interest, taxes, depreciation and amortization (EBITDA), while the second is how often its earnings before interest and taxes (EBIT) covers its interest expense (or its interests, for short). Thus, we consider debt to earnings with and without amortization and depreciation expense.

L’Occitane International’s net debt is only 0.42 times its EBITDA. And its EBIT covers its interest charges 22.7 times. One could therefore say that he is no more threatened by his debt than an elephant is by a mouse. On top of that, we are pleased to report that L’Occitane International increased its EBIT by 58%, reducing the specter of future debt repayments. There is no doubt that we learn the most about debt from the balance sheet. But ultimately, the company’s future profitability will decide whether L’Occitane International can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free analyst earnings forecast report interesting.

Finally, a company can only repay its debts with cash, not book profits. It is therefore worth checking how much of this EBIT is supported by free cash flow. Over the past three years, L’Occitane International has actually produced more free cash flow than EBIT. This kind of strong cash generation warms our hearts like a puppy in a bumblebee suit.

Our point of view

Fortunately, L’Occitane International’s impressive interest coverage means it has the upper hand on its debt. And the good news does not stop there, since its conversion of EBIT into free cash flow also confirms this impression! Overall, we do not believe that L’Occitane International is taking bad risks, as its debt seems modest to us. So we are not worried about using a little leverage on the balance sheet. 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. To this end, you should be aware of the 1 warning sign we spotted with L’Occitane International.

In the end, sometimes it’s easier to focus on companies that don’t even need to take on debt. Readers can access a list of growth stocks with no net debt 100% freeat present.

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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