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. As with many other companies DFS Furniture plc (LON:DFS) makes use of debt. But the real question is whether this debt is making the company risky.
What Risk Does Debt Bring?
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. 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, debt can be an important tool in businesses, particularly capital heavy businesses. The first step when considering a company's debt levels is to consider its cash and debt together.
What Is DFS Furniture's Debt?
You can click the graphic below for the historical numbers, but it shows that as of June 2020 DFS Furniture had UK£220.6m of debt, an increase on UK£194.7m, over one year. On the flip side, it has UK£66.8m in cash leading to net debt of about UK£153.8m.
How Strong Is DFS Furniture's Balance Sheet?
We can see from the most recent balance sheet that DFS Furniture had liabilities of UK£316.6m falling due within a year, and liabilities of UK£653.1m due beyond that. Offsetting these obligations, it had cash of UK£66.8m as well as receivables valued at UK£30.0m due within 12 months. So it has liabilities totalling UK£872.9m more than its cash and near-term receivables, combined.
The deficiency here weighs heavily on the UK£523.5m company itself, as if a child were struggling under the weight of an enormous back-pack full of books, his sports gear, and a trumpet. So we'd watch its balance sheet closely, without a doubt. After all, DFS Furniture would likely require a major re-capitalisation if it had to pay its creditors today. 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 DFS Furniture'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.
Over 12 months, DFS Furniture made a loss at the EBIT level, and saw its revenue drop to UK£725m, which is a fall of 26%. That makes us nervous, to say the least.
Not only did DFS Furniture's revenue slip over the last twelve months, but it also produced negative earnings before interest and tax (EBIT). To be specific the EBIT loss came in at UK£27m. Considering that alongside the liabilities mentioned above make us nervous about the company. It would need to improve its operations quickly for us to be interested in it. It's fair to say the loss of UK£69m didn't encourage us either; we'd like to see a profit. And until that time we think this is a risky stock. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. Be aware that DFS Furniture is showing 3 warning signs in our investment analysis , you should know about...
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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