Here's Why Myer Holdings (ASX:MYR) Can Manage Its Debt Responsibly

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.' 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. As with many other companies Myer Holdings Limited (ASX:MYR) makes use of debt. But the more important question is: how much risk is that debt creating?

What Risk Does Debt Bring?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. 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. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. When we think about a company's use of debt, we first look at cash and debt together.

View our latest analysis for Myer Holdings

What Is Myer Holdings's Net Debt?

The image below, which you can click on for greater detail, shows that Myer Holdings had debt of AU$66.8m at the end of July 2021, a reduction from AU$78.6m over a year. However, its balance sheet shows it holds AU$176.2m in cash, so it actually has AU$109.4m net cash.

How Healthy Is Myer Holdings' Balance Sheet?

The latest balance sheet data shows that Myer Holdings had liabilities of AU$589.7m due within a year, and liabilities of AU$1.65b falling due after that. Offsetting these obligations, it had cash of AU$176.2m as well as receivables valued at AU$28.1m due within 12 months. So its liabilities total AU$2.04b more than the combination of its cash and short-term receivables.

This deficit casts a shadow over the AU$487.3m company, like a colossus towering over mere mortals. So we definitely think shareholders need to watch this one closely. After all, Myer Holdings would likely require a major re-capitalisation if it had to pay its creditors today. Myer Holdings boasts net cash, so it's fair to say it does not have a heavy debt load, even if it does have very significant liabilities, in total.

Notably, Myer Holdings's EBIT launched higher than Elon Musk, gaining a whopping 145% on last year. 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 Myer 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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. While Myer Holdings 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. Over the last three years, Myer Holdings actually produced more free cash flow than EBIT. That sort of strong cash generation warms our hearts like a puppy in a bumblebee suit.

Summing up

Although Myer Holdings's balance sheet isn't particularly strong, due to the total liabilities, it is clearly positive to see that it has net cash of AU$109.4m. And it impressed us with free cash flow of AU$220m, being 146% of its EBIT. So we don't have any problem with Myer Holdings's use of debt. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. To that end, you should learn about the 2 warning signs we've spotted with Myer Holdings (including 1 which is significant) .

At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.

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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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