David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the permanent loss of capital. It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. We can see that Premier Investments Limited (ASX:PMV) 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. 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, plenty of companies use debt to fund growth, without any negative consequences. When we think about a company's use of debt, we first look at cash and debt together.
How Much Debt Does Premier Investments Carry?
As you can see below, Premier Investments had AU$103.8m of debt at January 2020, down from AU$138.8m a year prior. But it also has AU$216.9m in cash to offset that, meaning it has AU$113.1m net cash.
A Look At Premier Investments's Liabilities
Zooming in on the latest balance sheet data, we can see that Premier Investments had liabilities of AU$343.3m due within 12 months and liabilities of AU$393.6m due beyond that. Offsetting these obligations, it had cash of AU$216.9m as well as receivables valued at AU$15.5m due within 12 months. So it has liabilities totalling AU$504.5m more than its cash and near-term receivables, combined.
Given Premier Investments has a market capitalization of AU$2.68b, it's hard to believe these liabilities pose much threat. But there are sufficient liabilities that we would certainly recommend shareholders continue to monitor the balance sheet, going forward. Despite its noteworthy liabilities, Premier Investments boasts net cash, so it's fair to say it does not have a heavy debt load!
Also good is that Premier Investments grew its EBIT at 18% over the last year, further increasing its ability to manage debt. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Premier Investments 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.
But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. Premier Investments may have net cash on the balance sheet, but it is still interesting to look at how well the business converts its earnings before interest and tax (EBIT) to free cash flow, because that will influence both its need for, and its capacity to manage debt. Over the last three years, Premier Investments recorded free cash flow worth a fulsome 83% of its EBIT, which is stronger than we'd usually expect. That positions it well to pay down debt if desirable to do so.
While Premier Investments does have more liabilities than liquid assets, it also has net cash of AU$113.1m. The cherry on top was that in converted 83% of that EBIT to free cash flow, bringing in AU$239m. So is Premier Investments's debt a risk? It doesn't seem so to us. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. To that end, you should be aware of the 2 warning signs we've spotted with Premier Investments .
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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