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Does Leon's Furniture (TSE:LNF) Have A Healthy Balance Sheet?

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·4 min read
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Legendary fund manager Li Lu (who Charlie Munger backed) once said, '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. As with many other companies Leon's Furniture Limited (TSE:LNF) makes use of debt. But the more important question is: how much risk is that debt creating?

What Risk Does Debt Bring?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. 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, debt can be an important tool in businesses, particularly capital heavy businesses. When we think about a company's use of debt, we first look at cash and debt together.

See our latest analysis for Leon's Furniture

What Is Leon's Furniture's Net Debt?

You can click the graphic below for the historical numbers, but it shows that as of March 2022 Leon's Furniture had CA$240.0m of debt, an increase on CA$90.0m, over one year. However, it does have CA$246.9m in cash offsetting this, leading to net cash of CA$6.84m.

debt-equity-history-analysis
debt-equity-history-analysis

A Look At Leon's Furniture's Liabilities

We can see from the most recent balance sheet that Leon's Furniture had liabilities of CA$831.4m falling due within a year, and liabilities of CA$683.4m due beyond that. Offsetting this, it had CA$246.9m in cash and CA$178.5m in receivables that were due within 12 months. So its liabilities total CA$1.09b more than the combination of its cash and short-term receivables.

This deficit is considerable relative to its market capitalization of CA$1.11b, so it does suggest shareholders should keep an eye on Leon's Furniture's use of debt. Should its lenders demand that it shore up the balance sheet, shareholders would likely face severe dilution. While it does have liabilities worth noting, Leon's Furniture also has more cash than debt, so we're pretty confident it can manage its debt safely.

And we also note warmly that Leon's Furniture grew its EBIT by 12% last year, making its debt load easier to handle. There's no doubt that we learn most about debt from the balance sheet. But ultimately the future profitability of the business will decide if Leon's Furniture can strengthen its balance sheet over time. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. Leon's Furniture 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, Leon's Furniture 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.

Summing Up

Although Leon's Furniture's balance sheet isn't particularly strong, due to the total liabilities, it is clearly positive to see that it has net cash of CA$6.84m. And it impressed us with free cash flow of CA$220m, being 132% of its EBIT. So we are not troubled with Leon's Furniture's debt use. 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. To that end, you should be aware of the 1 warning sign we've spotted with Leon's Furniture .

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an 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 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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