EPL (NSE: EPL) seems to be using debt quite wisely

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 risk.” It’s only natural to consider a company’s balance sheet when looking at its level of risk, as debt is often involved when a business collapses. We can see that EPL limited (NSE: EPL) uses debt in its business. But the real question is whether this debt makes the business risky.

What risk does debt entail?

Debts and other liabilities become risky for a business when it cannot easily meet these obligations, either with free cash flow or by raising capital at an attractive price. An integral part of capitalism is the process of “creative destruction” where bankrupt companies are ruthlessly liquidated by their bankers. However, a more common (but still costly) situation is where a company has to dilute its shareholders at a cheap share price just to get its debt under control. By replacing dilution, however, debt can be a very good tool for companies that need capital to invest in growth at high rates of return. The first step in examining a business’s debt levels is to consider its cash flow and debt together.

See our latest review for EPL

How much debt does EPL carry?

The image below, which you can click for more details, shows that in September 2021, EPL was in debt of 6.20 billion yen, up from 4.17 billion yen in a year. However, it has 2.61 billion yen in cash offsetting this, which leads to net debt of around 3.59 billion yen.

NSEI: EPL History of debt to equity January 4, 2022

How healthy is EPL’s track record?

We can see from the most recent balance sheet that EPL had liabilities of 8.56 billion yen maturing within one year and liabilities of 5.14 billion yen beyond. In return, he had 2.61 billion yen in cash and 6.18 billion yen in receivables due within 12 months. It therefore has liabilities totaling 4.91 billion yen more than its cash and short-term receivables combined.

Considering that listed EPL shares are worth a total of 66.2 billion yen, it seems unlikely that this level of liabilities poses a major threat. Having said that, it is clear that we must continue to monitor his record lest it get worse.

We measure a company’s indebtedness relative to its earning power by looking at its net debt divided by its earnings before interest, taxes, depreciation, and amortization (EBITDA) and calculating the ease with which its earnings before interest and taxes (EBIT ) covers its interests. costs (interest coverage). The advantage of this approach is that we take into account both the absolute amount of debt (with net debt versus EBITDA) and the actual interest charges associated with this debt (with its coverage rate). interests).

EPL has a low net debt to EBITDA ratio of just 0.62. And its EBIT easily covers its interest costs, being 15.7 times greater. So we’re pretty relaxed about its ultra-conservative use of debt. But the other side of the story is that EPL has seen its EBIT drop 5.3% in the past year. This type of decline, if it continues, will obviously make debt more difficult to manage. When analyzing debt levels, the balance sheet is the obvious place to start. But ultimately, the company’s future profitability will decide whether EPL can strengthen its balance sheet over time. So if you are focused on the future you can check this out free report showing analysts’ earnings forecasts.

But our last consideration is also important, because a business cannot pay its debts with paper profits; he needs hard cash. We must therefore clearly examine whether this EBIT leads to the corresponding free cash flow. Over the past three years, EPL has generated free cash flow of 80% of its very robust EBIT, more than we expected. This puts him in a very strong position to pay off the debt.

Our point of view

The good news is that EPL’s demonstrated ability to cover its interest costs with its EBIT delights us like a fluffy puppy does a toddler. But frankly, we think its EBIT growth rate undermines that impression a bit. Looking at the big picture, we think EPL’s use of debt looks very reasonable and we don’t care. While debt comes with risk, when used wisely, it can also generate a better return on equity. Over time, stock prices tend to follow earnings per share, so if you are interested in EPL, you may want to click here to view an interactive chart of its historical earnings per share.

Of course, if you are the type of investor who prefers to buy stocks without going into debt, feel free to check out our exclusive list of cash net growth stocks today.

This Simply Wall St article is general in nature. We provide commentary based on historical data and analyst forecasts using only unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock and does not take into account your goals or your financial situation. Our aim is to bring you long-term, targeted analysis based on fundamental data. Note that our analysis may not take into account the latest announcements from price sensitive companies or qualitative documents. Simply Wall St has no position in any of the stocks mentioned.

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