Does Leon's Furniture (TSE:LNF) Have A Healthy Balance Sheet?

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 can see that Leon's Furniture Limited (TSE:LNF) does use debt in its business. But the real question is whether this debt is making the company risky.

When Is Debt A Problem?

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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. 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.

See our latest analysis for Leon's Furniture

How Much Debt Does Leon's Furniture Carry?

You can click the graphic below for the historical numbers, but it shows that as of December 2022 Leon's Furniture had CA$234.4m of debt, an increase on CA$90.0m, over one year. However, it does have CA$226.0m in cash offsetting this, leading to net debt of about CA$8.43m.

How Healthy Is Leon's Furniture's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Leon's Furniture had liabilities of CA$610.2m due within 12 months and liabilities of CA$654.5m due beyond that. On the other hand, it had cash of CA$226.0m and CA$188.7m worth of receivables due within a year. So it has liabilities totalling CA$850.1m more than its cash and near-term receivables, combined.

This deficit is considerable relative to its market capitalization of CA$1.26b, so it does suggest shareholders should keep an eye on Leon's Furniture's use of debt. Should its lenders demand that it shore up the balance sheet, shareholders would likely face severe dilution. But either way, Leon's Furniture has virtually no net debt, so it's fair to say it does not have a heavy debt load!

We use two main ratios to inform us about debt levels relative to earnings. The first is net debt divided by earnings before interest, tax, depreciation, and amortization (EBITDA), while the second is how many times its earnings before interest and tax (EBIT) covers its interest expense (or its interest cover, for short). The advantage of this approach is that we take into account both the absolute quantum of debt (with net debt to EBITDA) and the actual interest expenses associated with that debt (with its interest cover ratio).

Leon's Furniture has very little debt (net of cash), and boasts a debt to EBITDA ratio of 0.03 and EBIT of 11.8 times the interest expense. So relative to past earnings, the debt load seems trivial. On the other hand, Leon's Furniture's EBIT dived 12%, over the last year. We think hat kind of performance, if repeated frequently, could well lead to difficulties for the stock. There's no doubt that we learn most about debt from the balance sheet. But ultimately the future profitability of the business will decide if Leon's Furniture can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So it's worth checking how much of that EBIT is backed by free cash flow. Happily for any shareholders, Leon's Furniture actually produced more free cash flow than EBIT over the last three years. That sort of strong cash conversion gets us as excited as the crowd when the beat drops at a Daft Punk concert.

Our View

Both Leon's Furniture's ability to to convert EBIT to free cash flow and its net debt to EBITDA gave us comfort that it can handle its debt. On the other hand, its EBIT growth rate makes us a little less comfortable about its debt. When we consider all the elements mentioned above, it seems to us that Leon's Furniture is managing its debt quite well. Having said that, the load is sufficiently heavy that we would recommend any shareholders keep a close eye on it. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. We've identified 2 warning signs with Leon's Furniture (at least 1 which is significant) , and understanding them should be part of your investment process.

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.