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. Importantly, Signet Jewelers Limited (NYSE:SIG) does carry debt. But is this debt a concern to shareholders?
When Is Debt A Problem?
Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. 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 examine debt levels, we first consider both cash and debt levels, together.
What Is Signet Jewelers's Debt?
The chart below, which you can click on for greater detail, shows that Signet Jewelers had US$147.2m in debt in July 2022; about the same as the year before. However, it does have US$851.7m in cash offsetting this, leading to net cash of US$704.5m.
A Look At Signet Jewelers' Liabilities
The latest balance sheet data shows that Signet Jewelers had liabilities of US$1.92b due within a year, and liabilities of US$2.22b falling due after that. Offsetting this, it had US$851.7m in cash and US$154.1m in receivables that were due within 12 months. So its liabilities total US$3.14b more than the combination of its cash and short-term receivables.
Given this deficit is actually higher than the company's market capitalization of US$2.57b, we think shareholders really should watch Signet Jewelers's debt levels, like a parent watching their child ride a bike for the first time. In the scenario where the company had to clean up its balance sheet quickly, it seems likely shareholders would suffer extensive dilution. Given that Signet Jewelers has more cash than debt, we're pretty confident it can handle its debt, despite the fact that it has a lot of liabilities in total.
While Signet Jewelers doesn't seem to have gained much on the EBIT line, at least earnings remain stable for now. 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 Signet Jewelers 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.
Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. While Signet Jewelers 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, Signet Jewelers actually produced more free cash flow than EBIT over the last three years. That sort of strong cash conversion gets us as excited as the crowd when the beat drops at a Daft Punk concert.
Although Signet Jewelers'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$704.5m. And it impressed us with free cash flow of US$528m, being 165% of its EBIT. So we are not troubled with Signet Jewelers's debt use. 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. Be aware that Signet Jewelers is showing 3 warning signs in our investment analysis , and 1 of those can't be ignored...
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.
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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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