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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. Importantly, Levi Strauss & Co. (NYSE:LEVI) does carry debt. But is this debt a concern to shareholders?
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. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we examine debt levels, we first consider both cash and debt levels, together.
What Is Levi Strauss's Net Debt?
You can click the graphic below for the historical numbers, but it shows that as of November 2020 Levi Strauss had US$1.56b of debt, an increase on US$1.01b, over one year. However, its balance sheet shows it holds US$1.59b in cash, so it actually has US$29.4m net cash.
How Healthy Is Levi Strauss' Balance Sheet?
According to the last reported balance sheet, Levi Strauss had liabilities of US$1.55b due within 12 months, and liabilities of US$2.79b due beyond 12 months. Offsetting these obligations, it had cash of US$1.59b as well as receivables valued at US$540.2m due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by US$2.21b.
This deficit isn't so bad because Levi Strauss is worth US$9.68b, and thus could probably raise enough capital to shore up its balance sheet, if the need arose. But we definitely want to keep our eyes open to indications that its debt is bringing too much risk. While it does have liabilities worth noting, Levi Strauss also has more cash than debt, so we're pretty confident it can manage its debt safely.
Importantly, Levi Strauss's EBIT fell a jaw-dropping 73% in the last twelve months. If that earnings trend continues then paying off its debt will be about as easy as herding cats on to a roller coaster. 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 Levi Strauss can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.
Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. While Levi Strauss 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, Levi Strauss recorded free cash flow worth 68% 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.
Although Levi Strauss's balance sheet isn't particularly strong, due to the total liabilities, it is clearly positive to see that it has net cash of US$29.4m. And it impressed us with free cash flow of US$339m, being 68% of its EBIT. So although we see some areas for improvement, we're not too worried about Levi Strauss's balance sheet. 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. For instance, we've identified 2 warning signs for Levi Strauss (1 is a bit concerning) you should be aware of.
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.
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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