Does Zalando (ETR:ZAL) Have A Healthy Balance Sheet?

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. We can see that Zalando SE (ETR:ZAL) does use debt in its business. But is this debt a concern to shareholders?

What Risk Does Debt Bring?

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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

See our latest analysis for Zalando

What Is Zalando's Net Debt?

You can click the graphic below for the historical numbers, but it shows that as of December 2020 Zalando had €1.25b of debt, an increase on €5.50m, over one year. But it also has €2.69b in cash to offset that, meaning it has €1.44b net cash.

How Strong Is Zalando's Balance Sheet?

According to the last reported balance sheet, Zalando had liabilities of €2.94b due within 12 months, and liabilities of €1.40b due beyond 12 months. On the other hand, it had cash of €2.69b and €770.6m worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by €881.8m.

Since publicly traded Zalando shares are worth a very impressive total of €21.6b, it seems unlikely that this level of liabilities would be a major threat. But there are sufficient liabilities that we would certainly recommend shareholders continue to monitor the balance sheet, going forward. Despite its noteworthy liabilities, Zalando boasts net cash, so it's fair to say it does not have a heavy debt load!

Even more impressive was the fact that Zalando grew its EBIT by 129% over twelve months. That boost will make it even easier to pay down debt going forward. 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 Zalando'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. Zalando 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. In the last three years, Zalando's free cash flow amounted to 33% of its EBIT, less than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.

Summing up

We could understand if investors are concerned about Zalando's liabilities, but we can be reassured by the fact it has has net cash of €1.44b. And we liked the look of last year's 129% year-on-year EBIT growth. So is Zalando's debt a risk? It doesn't seem so to us. 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. For instance, we've identified 1 warning sign for Zalando that you should be aware of.

When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.

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This article by Simply Wall St is general in nature. 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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