Hermès International Société en commandite par actions (EPA:RMS) Seems To Use Debt Quite Sensibly

David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the 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 note that Hermès International Société en commandite par actions (EPA:RMS) does have debt on its balance sheet. But should shareholders be worried about its use of debt?

Why Does Debt Bring Risk?

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. When we examine debt levels, we first consider both cash and debt levels, together.

See our latest analysis for Hermès International Société en commandite par actions

What Is Hermès International Société en commandite par actions's Net Debt?

You can click the graphic below for the historical numbers, but it shows that Hermès International Société en commandite par actions had €42.9m of debt in December 2020, down from €50.1m, one year before. However, it does have €4.73b in cash offsetting this, leading to net cash of €4.69b.

How Strong Is Hermès International Société en commandite par actions' Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Hermès International Société en commandite par actions had liabilities of €1.84b due within 12 months and liabilities of €1.82b due beyond that. Offsetting this, it had €4.73b in cash and €313.2m in receivables that were due within 12 months. So it can boast €1.39b more liquid assets than total liabilities.

Having regard to Hermès International Société en commandite par actions' size, it seems that its liquid assets are well balanced with its total liabilities. So it's very unlikely that the €98.7b company is short on cash, but still worth keeping an eye on the balance sheet. Simply put, the fact that Hermès International Société en commandite par actions has more cash than debt is arguably a good indication that it can manage its debt safely.

On the other hand, Hermès International Société en commandite par actions's EBIT dived 16%, over the last year. If that rate of decline in earnings continues, the company could find itself in a tight spot. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately the future profitability of the business will decide if Hermès International Société en commandite par actions 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. Hermès International Société en commandite par actions 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, Hermès International Société en commandite par actions recorded free cash flow worth 69% 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

While it is always sensible to investigate a company's debt, in this case Hermès International Société en commandite par actions has €4.69b in net cash and a decent-looking balance sheet. The cherry on top was that in converted 69% of that EBIT to free cash flow, bringing in €1.2b. So we don't have any problem with Hermès International Société en commandite par actions's use of debt. Above most other metrics, we think its important to track how fast earnings per share is growing, if at all. If you've also come to that realization, you're in luck, because today you can view this interactive graph of Hermès International Société en commandite par actions's earnings per share history for free.

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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