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.' 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 Revolve Group, Inc. (NYSE:RVLV) does use debt in its business. But the more important question is: how much risk is that debt creating?
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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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. 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 examine debt levels, we first consider both cash and debt levels, together.
What Is Revolve Group's Debt?
You can click the graphic below for the historical numbers, but it shows that as of March 2020 Revolve Group had US$30.0m of debt, an increase on none, over one year. However, its balance sheet shows it holds US$103.6m in cash, so it actually has US$73.6m net cash.
How Strong Is Revolve Group's Balance Sheet?
Zooming in on the latest balance sheet data, we can see that Revolve Group had liabilities of US$123.4m due within 12 months and no liabilities due beyond that. Offsetting this, it had US$103.6m in cash and US$3.99m in receivables that were due within 12 months. So its liabilities total US$15.8m more than the combination of its cash and short-term receivables.
This state of affairs indicates that Revolve Group's balance sheet looks quite solid, as its total liabilities are just about equal to its liquid assets. So while it's hard to imagine that the US$1.22b company is struggling for cash, we still think it's worth monitoring its balance sheet. While it does have liabilities worth noting, Revolve Group also has more cash than debt, so we're pretty confident it can manage its debt safely.
And we also note warmly that Revolve Group grew its EBIT by 12% last year, making its debt load easier to handle. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Revolve Group 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 company can only pay off debt with cold hard cash, not accounting profits. While Revolve Group 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. During the last three years, Revolve Group produced sturdy free cash flow equating to 62% of its EBIT, about what we'd expect. This cold hard cash means it can reduce its debt when it wants to.
While it is always sensible to look at a company's total liabilities, it is very reassuring that Revolve Group has US$73.6m in net cash. So we don't think Revolve Group's use of debt is risky. 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. Case in point: We've spotted 1 warning sign for Revolve Group you should be aware of.
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.
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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