We Think Prada (HKG:1913) Can Manage Its Debt With Ease

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.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. Importantly, Prada S.p.A. (HKG:1913) does carry 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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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, 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 Prada

How Much Debt Does Prada Carry?

The chart below, which you can click on for greater detail, shows that Prada had €745.3m in debt in December 2021; about the same as the year before. However, its balance sheet shows it holds €990.0m in cash, so it actually has €244.8m net cash.

How Healthy Is Prada's Balance Sheet?

According to the last reported balance sheet, Prada had liabilities of €1.42b due within 12 months, and liabilities of €2.41b due beyond 12 months. On the other hand, it had cash of €990.0m and €418.2m worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by €2.42b.

Since publicly traded Prada shares are worth a very impressive total of €13.6b, it seems unlikely that this level of liabilities would be a major threat. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time. Despite its noteworthy liabilities, Prada boasts net cash, so it's fair to say it does not have a heavy debt load!

Better yet, Prada grew its EBIT by 292% last year, which is an impressive improvement. If maintained that growth will make the debt even more manageable in the years ahead. 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 Prada 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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. While Prada 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. Happily for any shareholders, Prada actually produced more free cash flow than EBIT over the last three years. That sort of strong cash generation warms our hearts like a puppy in a bumblebee suit.

Summing up

While Prada does have more liabilities than liquid assets, it also has net cash of €244.8m. And it impressed us with free cash flow of €924m, being 195% of its EBIT. So we don't think Prada's use of debt is risky. Over time, share prices tend to follow earnings per share, so if you're interested in Prada, you may well want to click here to check an interactive graph of its earnings per share history.

If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.

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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.