Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk. When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. We can see that Hermès International Société en commandite par actions (EPA:RMS) does use debt in its business. But the real question is whether this debt is making the company risky.
Why Does Debt Bring Risk?
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. If things get really bad, the lenders can take control of the business. 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. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. The first step when considering a company's debt levels is to consider its cash and debt together.
How Much Debt Does Hermès International Société en commandite par actions Carry?
You can click the graphic below for the historical numbers, but it shows that as of June 2019 Hermès International Société en commandite par actions had €54.4m of debt, an increase on €39.3m, over one year. However, its balance sheet shows it holds €3.55b in cash, so it actually has €3.50b net cash.
How Healthy Is Hermès International Société en commandite par actions's Balance Sheet?
We can see from the most recent balance sheet that Hermès International Société en commandite par actions had liabilities of €1.81b falling due within a year, and liabilities of €1.22b due beyond that. On the other hand, it had cash of €3.55b and €344.2m worth of receivables due within a year. So it can boast €865.6m more liquid assets than total liabilities.
This state of affairs indicates that Hermès International Société en commandite par actions's balance sheet looks quite solid, as its total liabilities are just about equal to its liquid assets. So it's very unlikely that the €68.0b company is short on cash, but still worth keeping an eye on the balance sheet. Succinctly put, Hermès International Société en commandite par actions boasts net cash, so it's fair to say it does not have a heavy debt load!
Fortunately, Hermès International Société en commandite par actions grew its EBIT by 9.1% in the last year, making that debt load look even more manageable. The balance sheet is clearly the area to focus on when you are analysing debt. But it is future earnings, more than anything, that will determine Hermès International Société en commandite par actions'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.
But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. While Hermès International Société en commandite par actions 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, Hermès International Société en commandite par actions recorded free cash flow worth 70% 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.
While it is always sensible to investigate a company's debt, in this case Hermès International Société en commandite par actions has €3.50b in net cash and a decent-looking balance sheet. And it impressed us with free cash flow of €1.4b, being 70% of its EBIT. So is Hermès International Société en commandite par actions's debt a risk? It doesn't seem so to us. Over time, share prices tend to follow earnings per share, so if you're interested in Hermès International Société en commandite par actions, you may well want to click here to check an interactive graph of its earnings per share history.
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.
If you spot an error that warrants correction, please contact the editor at email@example.com. 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. Simply Wall St has no position in the stocks mentioned.
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