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Hooker Furniture (NASDAQ:HOFT) Seems To Use Debt Quite Sensibly

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Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' 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. We can see that Hooker Furniture Corporation (NASDAQ:HOFT) does use debt in its business. But the real question is whether this debt is making the company risky.

When Is Debt A Problem?

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 common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. 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 Hooker Furniture

How Much Debt Does Hooker Furniture Carry?

As you can see below, Hooker Furniture had US$27.2m of debt at August 2020, down from US$32.5m a year prior. However, it does have US$82.2m in cash offsetting this, leading to net cash of US$55.0m.

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

How Healthy Is Hooker Furniture's Balance Sheet?

The latest balance sheet data shows that Hooker Furniture had liabilities of US$71.0m due within a year, and liabilities of US$44.2m falling due after that. Offsetting this, it had US$82.2m in cash and US$67.1m in receivables that were due within 12 months. So it can boast US$34.1m more liquid assets than total liabilities.

This surplus suggests that Hooker Furniture has a conservative balance sheet, and could probably eliminate its debt without much difficulty. 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 49% over the last year. When a company sees its earnings tank, it can sometimes find its relationships with its lenders turn sour. When analysing debt levels, the balance sheet is the obvious place to start. 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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs 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 last three years, Hooker Furniture recorded free cash flow worth a fulsome 97% of its EBIT, which is stronger than we'd usually expect. That positions it well to pay down debt if desirable to do so.

Summing up

While we empathize with investors who find debt concerning, you should keep in mind that Hooker Furniture has net cash of US$55.0m, as well as more liquid assets than liabilities. The cherry on top was that in converted 97% of that EBIT to free cash flow, bringing in US$82m. So we are not troubled with Hooker Furniture's debt use. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. Consider for instance, the ever-present spectre of investment risk. We've identified 2 warning signs with Hooker Furniture , and understanding them should be part of your investment process.

When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.

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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