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David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the permanent loss of capital. So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. We can see that Hooker Furniture Corporation (NASDAQ:HOFT) does use debt in its business. But is this debt a concern to shareholders?
When Is Debt Dangerous?
Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.
See our latest analysis for Hooker Furniture
What Is Hooker Furniture's Debt?
The image below, which you can click on for greater detail, shows that Hooker Furniture had debt of US$30.1m at the end of February 2020, a reduction from US$35.5m over a year. But it also has US$36.0m in cash to offset that, meaning it has US$5.92m net cash.
How Strong Is Hooker Furniture's Balance Sheet?
Zooming in on the latest balance sheet data, we can see that Hooker Furniture had liabilities of US$50.1m due within 12 months and liabilities of US$69.5m due beyond that. Offsetting this, it had US$36.0m in cash and US$88.4m in receivables that were due within 12 months. So it can boast US$4.85m more liquid assets than total liabilities.
This short term liquidity is a sign that Hooker Furniture could probably pay off its debt with ease, as its balance sheet is far from stretched. Simply put, the fact that Hooker Furniture has more cash than debt is arguably a good indication that it can manage its debt safely.
It is just as well that Hooker Furniture's load is not too heavy, because its EBIT was down 58% over the last year. When a company sees its earnings tank, it can sometimes find its relationships with its lenders turn sour. 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 Hooker 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, while the tax-man may adore accounting profits, lenders only accept cold hard cash. While Hooker Furniture has net cash on its balance sheet, it's still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. Over the most recent three years, Hooker Furniture recorded free cash flow worth 55% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This free cash flow puts the company in a good position to pay down debt, when appropriate.
Summing up
While it is always sensible to investigate a company's debt, in this case Hooker Furniture has US$5.92m in net cash and a decent-looking balance sheet. So we don't have any problem with Hooker Furniture's use of debt. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. Case in point: We've spotted 2 warning signs for Hooker Furniture 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.
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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. Thank you for reading.
