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Lovisa Holdings (ASX:LOV) Seems To Use Debt Rather Sparingly

·4 min read

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 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 Lovisa Holdings Limited (ASX:LOV) does use debt in its business. But the real question is whether this debt is making the company risky.

What Risk Does Debt Bring?

Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. 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. When we think about a company's use of debt, we first look at cash and debt together.

View our latest analysis for Lovisa Holdings

What Is Lovisa Holdings's Debt?

The image below, which you can click on for greater detail, shows that at July 2022 Lovisa Holdings had debt of AU$10.0m, up from none in one year. However, its balance sheet shows it holds AU$36.2m in cash, so it actually has AU$26.2m net cash.

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

A Look At Lovisa Holdings' Liabilities

Zooming in on the latest balance sheet data, we can see that Lovisa Holdings had liabilities of AU$131.9m due within 12 months and liabilities of AU$173.1m due beyond that. Offsetting these obligations, it had cash of AU$36.2m as well as receivables valued at AU$16.0m due within 12 months. So its liabilities total AU$252.7m more than the combination of its cash and short-term receivables.

Since publicly traded Lovisa Holdings shares are worth a total of AU$2.31b, it seems unlikely that this level of liabilities would be a major threat. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time. Despite its noteworthy liabilities, Lovisa Holdings boasts net cash, so it's fair to say it does not have a heavy debt load!

On top of that, Lovisa Holdings grew its EBIT by 95% over the last twelve months, and that growth will make it easier to handle its debt. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately the future profitability of the business will decide if Lovisa Holdings 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, while the tax-man may adore accounting profits, lenders only accept cold hard cash. While Lovisa Holdings 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. Happily for any shareholders, Lovisa Holdings actually produced more free cash flow than EBIT over the last three years. That sort of strong cash generation warms our hearts like a puppy in a bumblebee suit.

Summing Up

While Lovisa Holdings does have more liabilities than liquid assets, it also has net cash of AU$26.2m. And it impressed us with free cash flow of AU$93m, being 146% of its EBIT. So is Lovisa Holdings's debt a risk? It doesn't seem so to us. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. Case in point: We've spotted 1 warning sign for Lovisa Holdings 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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. 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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