Lovisa Holdings (ASX:LOV) Has A Rock Solid Balance Sheet

Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. We note that Lovisa Holdings Limited (ASX:LOV) does have debt on its balance sheet. But is this debt a concern to shareholders?

When Is Debt Dangerous?

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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.

Check out the opportunities and risks within the AU Specialty Retail industry.

What Is Lovisa Holdings's Net Debt?

As you can see below, at the end of July 2022, Lovisa Holdings had AU$10.0m of debt, up from none a year ago. Click the image for more detail. But on the other hand it also has AU$36.2m in cash, leading to a AU$26.2m net cash position.

A Look At Lovisa Holdings' Liabilities

According to the last reported balance sheet, Lovisa Holdings had liabilities of AU$131.9m due within 12 months, and liabilities of AU$173.1m due beyond 12 months. On the other hand, it had cash of AU$36.2m and AU$16.0m worth of receivables due within a year. So its liabilities total AU$252.7m more than the combination of its cash and short-term receivables.

Given Lovisa Holdings has a market capitalization of AU$2.59b, it's hard to believe these liabilities pose much threat. But there are sufficient liabilities that we would certainly recommend shareholders continue to monitor the balance sheet, going forward. While it does have liabilities worth noting, Lovisa Holdings also has more cash than debt, so we're pretty confident it can manage its debt safely.

Better yet, Lovisa Holdings grew its EBIT by 154% last year, which is an impressive improvement. If maintained that growth will make the debt even more manageable in the years ahead. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately the future profitability of the business will decide if Lovisa Holdings 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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. Lovisa Holdings 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, Lovisa Holdings actually produced more free cash flow than EBIT. That sort of strong cash conversion gets us as excited as the crowd when the beat drops at a Daft Punk concert.

Summing Up

We could understand if investors are concerned about Lovisa Holdings's liabilities, but we can be reassured by the fact it has has net cash of AU$26.2m. The cherry on top was that in converted 161% of that EBIT to free cash flow, bringing in AU$93m. So we don't think Lovisa Holdings's use of debt is risky. 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. These risks can be hard to spot. Every company has them, and we've spotted 1 warning sign for Lovisa Holdings 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.