Warren Buffett famously said, 'Volatility is far from synonymous with risk.' 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 note that Ralph Lauren Corporation (NYSE:RL) does have debt on its balance sheet. But the real question is whether this debt is making the company risky.
What Risk Does Debt Bring?
Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. If things get really bad, the lenders can take control of the business. 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. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.
How Much Debt Does Ralph Lauren Carry?
You can click the graphic below for the historical numbers, but it shows that Ralph Lauren had US$695.3m of debt in June 2019, down from US$848.0m, one year before. However, its balance sheet shows it holds US$1.93b in cash, so it actually has US$1.23b net cash.
How Healthy Is Ralph Lauren's Balance Sheet?
According to the last reported balance sheet, Ralph Lauren had liabilities of US$1.59b due within 12 months, and liabilities of US$2.74b due beyond 12 months. Offsetting this, it had US$1.93b in cash and US$563.4m in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by US$1.84b.
While this might seem like a lot, it is not so bad since Ralph Lauren has a market capitalization of US$6.60b, and so it could probably strengthen its balance sheet by raising capital if it needed to. But we definitely want to keep our eyes open to indications that its debt is bringing too much risk. Despite its noteworthy liabilities, Ralph Lauren boasts net cash, so it's fair to say it does not have a heavy debt load!
Fortunately, Ralph Lauren grew its EBIT by 7.0% 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 Ralph Lauren'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.
Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. Ralph Lauren 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, Ralph Lauren recorded free cash flow worth a fulsome 98% of its EBIT, which is stronger than we'd usually expect. That puts it in a very strong position to pay down debt.
While Ralph Lauren does have more liabilities than liquid assets, it also has net cash of US$1.2b. And it impressed us with free cash flow of US$546m, being 98% of its EBIT. So is Ralph Lauren's debt a risk? It doesn't seem so to us. Of course, we wouldn't say no to the extra confidence that we'd gain if we knew that Ralph Lauren insiders have been buying shares: if you're on the same wavelength, you can find out if insiders are buying by clicking this link.
If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.
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