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

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. As with many other companies Hermès International Société en commandite par actions (EPA:RMS) makes use of debt. But is this debt a concern to shareholders?

When Is Debt Dangerous?

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, plenty of companies use debt to fund growth, without any negative consequences. When we think about a company's use of debt, we first look at cash and debt together.

Check out our latest analysis for Hermès International Société en commandite par actions

How Much Debt Does Hermès International Société en commandite par actions Carry?

As you can see below, Hermès International Société en commandite par actions had €38.0m of debt at June 2022, down from €43.4m a year prior. However, it does have €7.29b in cash offsetting this, leading to net cash of €7.26b.

A Look At Hermès International Société en commandite par actions' Liabilities

The latest balance sheet data shows that Hermès International Société en commandite par actions had liabilities of €2.73b due within a year, and liabilities of €2.08b falling due after that. Offsetting these obligations, it had cash of €7.29b as well as receivables valued at €472.0m due within 12 months. So it can boast €2.96b more liquid assets than total liabilities.

This surplus suggests that Hermès International Société en commandite par actions has a conservative balance sheet, and could probably eliminate its debt without much difficulty. 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.

Also positive, Hermès International Société en commandite par actions grew its EBIT by 29% in the last year, and that should make it 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 Hermès International Société en commandite par actions'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.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. While Hermès International Société en commandite par actions 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, Hermès International Société en commandite par actions recorded free cash flow worth 71% 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

While we empathize with investors who find debt concerning, you should keep in mind that Hermès International Société en commandite par actions has net cash of €7.26b, as well as more liquid assets than liabilities. And it impressed us with its EBIT growth of 29% over the last year. So we don't think Hermès International Société en commandite par actions's use of debt is risky. Over time, share prices tend to follow earnings per share, so if you're interested in Hermès International Société en commandite par actions, 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.