These 4 Measures Indicate That Zalando (ETR:ZAL) Is Using Debt Safely

The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. We note that Zalando SE (ETR:ZAL) does have debt on its balance sheet. But is this debt a concern to shareholders?

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 common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we examine debt levels, we first consider both cash and debt levels, together.

Check out our latest analysis for Zalando

What Is Zalando's Debt?

The image below, which you can click on for greater detail, shows that at June 2021 Zalando had debt of €885.6m, up from €379.1m in one year. But it also has €2.35b in cash to offset that, meaning it has €1.46b net cash.

A Look At Zalando's Liabilities

We can see from the most recent balance sheet that Zalando had liabilities of €2.92b falling due within a year, and liabilities of €1.56b due beyond that. Offsetting this, it had €2.35b in cash and €706.1m in receivables that were due within 12 months. So its liabilities total €1.43b more than the combination of its cash and short-term receivables.

Of course, Zalando has a titanic market capitalization of €23.8b, so these liabilities are probably manageable. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time. While it does have liabilities worth noting, Zalando also has more cash than debt, so we're pretty confident it can manage its debt safely.

Even more impressive was the fact that Zalando grew its EBIT by 190% over twelve months. That boost will make it even easier to pay down debt going forward. When analysing debt levels, the balance sheet is the obvious place to start. 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're focused on the future you can check out this free report showing analyst profit forecasts.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. While Zalando 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 most recent three years, Zalando recorded free cash flow worth 54% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This free cash flow puts the company in a good position to pay down debt, when appropriate.

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 €1.46b. And we liked the look of last year's 190% year-on-year EBIT growth. So we don't think Zalando's use of debt is risky. Over time, share prices tend to follow earnings per share, so if you're interested in Zalando, you may well want to click here to check an interactive graph of its earnings per share history.

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.

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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.
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