Is Premier Investments (ASX:PMV) A Risky Investment?

Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that '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 note that Premier Investments Limited (ASX:PMV) does have debt on its balance sheet. But the more important question is: how much risk is that debt creating?

When Is Debt Dangerous?

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. If things get really bad, the lenders can take control of the business. 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. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. The first step when considering a company's debt levels is to consider its cash and debt together.

See our latest analysis for Premier Investments

How Much Debt Does Premier Investments Carry?

You can click the graphic below for the historical numbers, but it shows that Premier Investments had AU$69.0m of debt in July 2022, down from AU$147.6m, one year before. However, its balance sheet shows it holds AU$481.6m in cash, so it actually has AU$412.6m net cash.

A Look At Premier Investments' Liabilities

We can see from the most recent balance sheet that Premier Investments had liabilities of AU$394.4m falling due within a year, and liabilities of AU$232.9m due beyond that. Offsetting this, it had AU$481.6m in cash and AU$11.0m in receivables that were due within 12 months. So its liabilities total AU$134.6m more than the combination of its cash and short-term receivables.

Since publicly traded Premier Investments shares are worth a total of AU$4.19b, it seems unlikely that this level of liabilities would be a major threat. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time. Despite its noteworthy liabilities, Premier Investments boasts net cash, so it's fair to say it does not have a heavy debt load!

The good news is that Premier Investments has increased its EBIT by 6.2% over twelve months, which should ease any concerns about debt repayment. The balance sheet is clearly the area to focus on when you are analysing debt. But it is future earnings, more than anything, that will determine Premier Investments's ability to maintain a healthy balance sheet going forward. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. While Premier Investments 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. Happily for any shareholders, Premier Investments actually produced more free cash flow than EBIT over the last three years. That sort of strong cash generation warms our hearts like a puppy in a bumblebee suit.

Summing Up

While it is always sensible to look at a company's total liabilities, it is very reassuring that Premier Investments has AU$412.6m in net cash. And it impressed us with free cash flow of AU$347m, being 130% of its EBIT. So is Premier Investments's debt a risk? It doesn't seem so to us. Given Premier Investments has a strong balance sheet is profitable and pays a dividend, it would be good to know how fast its dividends are growing, if at all. You can find out instantly by clicking this link.

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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

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.