These 4 Measures Indicate That Leon's Furniture (TSE:LNF) Is Using Debt Reasonably Well

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 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 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. 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, 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 think about a company's use of debt, we first look at cash and debt together.

View our latest analysis for Leon's Furniture

What Is Leon's Furniture's Debt?

As you can see below, Leon's Furniture had CA$90.0m of debt at September 2024, down from CA$160.0m a year prior. However, its balance sheet shows it holds CA$249.2m in cash, so it actually has CA$159.2m net cash.

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

According to the last reported balance sheet, Leon's Furniture had liabilities of CA$618.1m due within 12 months, and liabilities of CA$527.0m due beyond 12 months. On the other hand, it had cash of CA$249.2m and CA$192.4m worth of receivables due within a year. So it has liabilities totalling CA$703.5m more than its cash and near-term receivables, combined.

Leon's Furniture has a market capitalization of CA$1.74b, so it could very likely raise cash to ameliorate its balance sheet, if the need arose. However, it is still worthwhile taking a close look at its ability to pay off debt. Despite its noteworthy liabilities, Leon's Furniture boasts net cash, so it's fair to say it does not have a heavy debt load!

Fortunately, Leon's Furniture grew its EBIT by 5.3% in the last year, making that debt load look even more manageable. 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 Leon's Furniture'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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. Leon's Furniture 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 most recent three years, Leon's Furniture recorded free cash flow worth 70% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This cold hard cash means it can reduce its debt when it wants to.

Summing Up

Although Leon's Furniture's balance sheet isn't particularly strong, due to the total liabilities, it is clearly positive to see that it has net cash of CA$159.2m. The cherry on top was that in converted 70% of that EBIT to free cash flow, bringing in CA$230m. So we don't have any problem with Leon's Furniture's use of debt. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. For instance, we've identified 1 warning sign for Leon's Furniture that you should be aware of.

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.

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.