The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says '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. We note that Deckers Outdoor Corporation (NYSE:DECK) does have debt on its balance sheet. But is this debt a concern to shareholders?
What Risk Does Debt Bring?
Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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. The first step when considering a company's debt levels is to consider its cash and debt together.
What Is Deckers Outdoor's Debt?
As you can see below, Deckers Outdoor had US$31.4m of debt, at June 2019, which is about the same the year before. You can click the chart for greater detail. But on the other hand it also has US$502.6m in cash, leading to a US$471.3m net cash position.
How Strong Is Deckers Outdoor's Balance Sheet?
The latest balance sheet data shows that Deckers Outdoor had liabilities of US$441.7m due within a year, and liabilities of US$314.0m falling due after that. Offsetting this, it had US$502.6m in cash and US$169.0m in receivables that were due within 12 months. So its liabilities total US$84.1m more than the combination of its cash and short-term receivables.
Of course, Deckers Outdoor has a market capitalization of US$3.97b, so these liabilities are probably manageable. Having said that, it's clear that we should continue to monitor its balance sheet, lest it change for the worse. While it does have liabilities worth noting, Deckers Outdoor also has more cash than debt, so we're pretty confident it can manage its debt safely.
In addition to that, we're happy to report that Deckers Outdoor has boosted its EBIT by 39%, thus reducing the spectre of future debt repayments. There's no doubt that we learn most about debt from the balance sheet. But it is future earnings, more than anything, that will determine Deckers Outdoor's ability to maintain a healthy balance sheet going forward. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.
Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. Deckers Outdoor may have net cash on the balance sheet, but it is still interesting to look at how well the business converts its earnings before interest and tax (EBIT) to free cash flow, because that will influence both its need for, and its capacity to manage debt. Happily for any shareholders, Deckers Outdoor actually produced more free cash flow than EBIT over the last three years. That sort of strong cash generation warms our hearts like a puppy in a bumblebee suit.
While it is always sensible to look at a company's total liabilities, it is very reassuring that Deckers Outdoor has US$471m in net cash. And it impressed us with free cash flow of US$276m, being 104% of its EBIT. So we don't think Deckers Outdoor's use of debt is risky. We'd be very excited to see if Deckers Outdoor insiders have been snapping up shares. If you are too, then click on this link right now to take a (free) peek at our list of reported insider transactions.
At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.
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