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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.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. As with many other companies Canada Goose Holdings Inc. (TSE:GOOS) makes use of debt. But should shareholders be worried about its use of debt?
When Is Debt Dangerous?
Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we think about a company's use of debt, we first look at cash and debt together.
What Is Canada Goose Holdings's Net Debt?
As you can see below, at the end of December 2020, Canada Goose Holdings had CA$383.1m of debt, up from CA$147.6m a year ago. Click the image for more detail. However, its balance sheet shows it holds CA$469.0m in cash, so it actually has CA$85.9m net cash.
How Healthy Is Canada Goose Holdings' Balance Sheet?
We can see from the most recent balance sheet that Canada Goose Holdings had liabilities of CA$325.0m falling due within a year, and liabilities of CA$650.7m due beyond that. On the other hand, it had cash of CA$469.0m and CA$123.6m worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by CA$383.1m.
Since publicly traded Canada Goose Holdings shares are worth a total of CA$5.76b, it seems unlikely that this level of liabilities would be a major threat. Having said that, it's clear that we should continue to monitor its balance sheet, lest it change for the worse. Despite its noteworthy liabilities, Canada Goose Holdings boasts net cash, so it's fair to say it does not have a heavy debt load!
Shareholders should be aware that Canada Goose Holdings's EBIT was down 68% last year. If that earnings trend continues then paying off its debt will be about as easy as herding cats on to a roller coaster. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately the future profitability of the business will decide if Canada Goose Holdings 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. Canada Goose Holdings 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. Over the most recent three years, Canada Goose Holdings recorded free cash flow worth 57% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This cold hard cash means it can reduce its debt when it wants to.
We could understand if investors are concerned about Canada Goose Holdings's liabilities, but we can be reassured by the fact it has has net cash of CA$85.9m. So we don't have any problem with Canada Goose Holdings's use of debt. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. For instance, we've identified 4 warning signs for Canada Goose Holdings that you should be aware of.
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.
This article by Simply Wall St is general in nature. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.
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