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

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.' 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 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. 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, 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 Hermès International Société en commandite par actions

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

As you can see below, at the end of June 2023, Hermès International Société en commandite par actions had €58.0m of debt, up from €38.0m a year ago. Click the image for more detail. But on the other hand it also has €9.35b in cash, leading to a €9.29b net cash position.

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

According to the last reported balance sheet, Hermès International Société en commandite par actions had liabilities of €2.99b due within 12 months, and liabilities of €2.02b due beyond 12 months. Offsetting these obligations, it had cash of €9.35b as well as receivables valued at €431.0m due within 12 months. So it actually has €4.77b more liquid assets than total liabilities.

This short term liquidity is a sign that Hermès International Société en commandite par actions could probably pay off its debt with ease, as its balance sheet is far from stretched. 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. 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 Hermès International Société en commandite par actions can strengthen its balance sheet over time. 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. 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. During the last three years, Hermès International Société en commandite par actions produced sturdy free cash flow equating to 73% of its EBIT, about what we'd expect. 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 €9.29b, as well as more liquid assets than liabilities. And we liked the look of last year's 29% year-on-year EBIT growth. So is Hermès International Société en commandite par actions's debt a risk? It doesn't seem so to us. 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.