Does Harvey Norman Holdings (ASX:HVN) Have A Healthy Balance Sheet?

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 can see that Harvey Norman Holdings Limited (ASX:HVN) does use debt in its business. But the real question is whether this debt is making the company risky.

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When Is Debt Dangerous?

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. Of course, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. When we examine debt levels, we first consider both cash and debt levels, together.

What Is Harvey Norman Holdings's Net Debt?

As you can see below, at the end of December 2024, Harvey Norman Holdings had AU$888.9m of debt, up from AU$840.8m a year ago. Click the image for more detail. However, because it has a cash reserve of AU$314.2m, its net debt is less, at about AU$574.7m.

How Strong Is Harvey Norman Holdings' Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Harvey Norman Holdings had liabilities of AU$1.42b due within 12 months and liabilities of AU$2.11b due beyond that. On the other hand, it had cash of AU$314.2m and AU$882.4m worth of receivables due within a year. So it has liabilities totalling AU$2.34b more than its cash and near-term receivables, combined.

This deficit isn't so bad because Harvey Norman Holdings is worth AU$6.32b, and thus could probably raise enough capital to shore up 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.

See our latest analysis for Harvey Norman Holdings

We measure a company's debt load relative to its earnings power by looking at its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and by calculating how easily its earnings before interest and tax (EBIT) cover its interest expense (interest cover). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

Harvey Norman Holdings has a low net debt to EBITDA ratio of only 0.76. And its EBIT easily covers its interest expense, being 10.2 times the size. So you could argue it is no more threatened by its debt than an elephant is by a mouse. Harvey Norman Holdings's EBIT was pretty flat over the last year, but that shouldn't be an issue given the it doesn't have a lot of debt. There's no doubt that we learn most about debt from the balance sheet. But it is future earnings, more than anything, that will determine Harvey Norman Holdings'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, a business needs free cash flow to pay off debt; accounting profits just don't cut it. So the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. During the last three years, Harvey Norman Holdings produced sturdy free cash flow equating to 56% of its EBIT, about what we'd expect. This cold hard cash means it can reduce its debt when it wants to.

Our View

Harvey Norman Holdings's interest cover was a real positive on this analysis, as was its net debt to EBITDA. Having said that, its level of total liabilities somewhat sensitizes us to potential future risks to the balance sheet. When we consider all the elements mentioned above, it seems to us that Harvey Norman Holdings is managing its debt quite well. But a word of caution: we think debt levels are high enough to justify ongoing monitoring. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. Be aware that Harvey Norman Holdings is showing 2 warning signs in our investment analysis , you should know about...

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.