Swatch Group (VTX:UHR) Seems To Use Debt Quite Sensibly

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.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. We note that The Swatch Group AG (VTX:UHR) does have debt on its balance sheet. But is this debt a concern to shareholders?

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. 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, 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. The first step when considering a company's debt levels is to consider its cash and debt together.

Check out our latest analysis for Swatch Group

What Is Swatch Group's Net Debt?

You can click the graphic below for the historical numbers, but it shows that as of June 2024 Swatch Group had CHF34.0m of debt, an increase on CHF27.0m, over one year. But it also has CHF1.47b in cash to offset that, meaning it has CHF1.43b net cash.

How Strong Is Swatch Group's Balance Sheet?

According to the last reported balance sheet, Swatch Group had liabilities of CHF1.25b due within 12 months, and liabilities of CHF767.0m due beyond 12 months. On the other hand, it had cash of CHF1.47b and CHF783.0m worth of receivables due within a year. So it actually has CHF229.0m more liquid assets than total liabilities.

This surplus suggests that Swatch Group has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Simply put, the fact that Swatch Group has more cash than debt is arguably a good indication that it can manage its debt safely.

The modesty of its debt load may become crucial for Swatch Group if management cannot prevent a repeat of the 47% cut to EBIT over the last year. When it comes to paying off debt, falling earnings are no more useful than sugary sodas are for your health. 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 Swatch Group 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.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. While Swatch Group 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, Swatch Group reported free cash flow worth 18% of its EBIT, which is really quite low. For us, cash conversion that low sparks a little paranoia about is ability to extinguish debt.

Summing Up

While we empathize with investors who find debt concerning, you should keep in mind that Swatch Group has net cash of CHF1.43b, as well as more liquid assets than liabilities. So we don't have any problem with Swatch Group's use of debt. 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. To that end, you should be aware of the 3 warning signs we've spotted with Swatch Group .

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

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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.