Is Hermès International Société en commandite par actions (EPA:RMS) Using Too Much Debt?

Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk.' 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 the real question is whether this debt is making the company risky.

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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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, 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 think about a company's use of debt, we first look at cash and debt together.

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

The image below, which you can click on for greater detail, shows that Hermès International Société en commandite par actions had debt of €38.0m at the end of June 2022, a reduction from €43.4m over a year. However, its balance sheet shows it holds €7.29b in cash, so it actually has €7.26b net cash.

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 €2.73b due within 12 months and liabilities of €2.08b due beyond that. Offsetting these obligations, it had cash of €7.29b as well as receivables valued at €472.0m due within 12 months. So it actually has €2.96b 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 €151.9b 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.

Another good sign is that Hermès International Société en commandite par actions has been able to increase its EBIT by 29% in twelve months, making it easier to pay down debt. 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, 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 71% 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 it is always sensible to investigate a company's debt, in this case Hermès International Société en commandite par actions has €7.26b in net cash and a decent-looking balance sheet. 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. 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. 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.