Warren Buffett famously said, ‘Volatility is far from synonymous with risk.’ When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. As with many other companies Movado Group, Inc. (NYSE:MOV) makes use of debt. But should shareholders be worried about its use of debt?
When Is Debt A Problem?
Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. If things get really bad, the lenders can take control of the business. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. 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 step when considering a company’s debt levels is to consider its cash and debt together.
What Is Movado Group’s Net Debt?
The image below, which you can click on for greater detail, shows that at October 2019 Movado Group had debt of US$50.7m, up from US$49.6 in one year. But it also has US$116.4m in cash to offset that, meaning it has US$65.7m net cash.
How Healthy Is Movado Group’s Balance Sheet?
We can see from the most recent balance sheet that Movado Group had liabilities of US$137.4m falling due within a year, and liabilities of US$205.7m due beyond that. On the other hand, it had cash of US$116.4m and US$136.3m worth of receivables due within a year. So it has liabilities totalling US$90.5m more than its cash and near-term receivables, combined.
Movado Group has a market capitalization of US$445.4m, so it could very likely raise cash to ameliorate its balance sheet, if the need arose. But we definitely want to keep our eyes open to indications that its debt is bringing too much risk. While it does have liabilities worth noting, Movado Group also has more cash than debt, so we’re pretty confident it can manage its debt safely.
But the other side of the story is that Movado Group saw its EBIT decline by 8.3% over the last year. That sort of decline, if sustained, will obviously make debt harder to handle. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Movado Group’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.
But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. Movado Group 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. During the last three years, Movado Group produced sturdy free cash flow equating to 76% of its EBIT, about what we’d expect. This cold hard cash means it can reduce its debt when it wants to.
While Movado Group does have more liabilities than liquid assets, it also has net cash of US$65.7m. The cherry on top was that in converted 76% of that EBIT to free cash flow, bringing in US$1.7m. So we are not troubled with Movado Group’s debt use. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. Case in point: We’ve spotted 3 warning signs for Movado Group you should be aware of, and 1 of them can’t be ignored.
If you’re interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.
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