Warren Buffett famously said, 'Volatility is far from synonymous with risk.' 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. Importantly, PVH Corp. (NYSE:PVH) does carry debt. But is this debt a concern to shareholders?
When Is Debt Dangerous?
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. 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. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.
What Is PVH's Net Debt?
As you can see below, PVH had US$2.97b of debt, at August 2019, which is about the same the year before. You can click the chart for greater detail. However, it does have US$433.8m in cash offsetting this, leading to net debt of about US$2.54b.
How Healthy Is PVH's Balance Sheet?
Zooming in on the latest balance sheet data, we can see that PVH had liabilities of US$2.43b due within 12 months and liabilities of US$5.52b due beyond that. On the other hand, it had cash of US$433.8m and US$808.9m worth of receivables due within a year. So it has liabilities totalling US$6.71b more than its cash and near-term receivables, combined.
When you consider that this deficiency exceeds the company's US$6.47b market capitalization, you might well be inclined to review the balance sheet intently. In the scenario where the company had to clean up its balance sheet quickly, it seems likely shareholders would suffer extensive dilution.
We measure a company's debt load relative to its earnings power by looking at its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and by calculating how easily its earnings before interest and tax (EBIT) cover its interest expense (interest cover). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.
PVH's net debt of 1.9 times EBITDA suggests graceful use of debt. And the alluring interest cover (EBIT of 8.6 times interest expense) certainly does not do anything to dispel this impression. We note that PVH grew its EBIT by 20% in the last year, and that should make it easier to pay down debt, going forward. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine PVH's ability to maintain a healthy balance sheet going forward. 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. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. Looking at the most recent three years, PVH recorded free cash flow of 49% of its EBIT, which is weaker than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.
While PVH's level of total liabilities does give us pause, its EBIT growth rate and interest cover suggest it can stay on top of its debt load. We think that PVH's debt does make it a bit risky, after considering the aforementioned data points together. That's not necessarily a bad thing, since leverage can boost returns on equity, but it is something to be aware of. In light of our reservations about the company's balance sheet, it seems sensible to check if insiders have been selling shares recently.
If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.
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