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.' 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 can see that Salvatore Ferragamo S.p.A. (BIT:SFER) does use debt in its business. But should shareholders be worried about its use of debt?
When Is Debt A Problem?
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. If things get really bad, the lenders can take control of the business. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we examine debt levels, we first consider both cash and debt levels, together.
See our latest analysis for Salvatore Ferragamo
How Much Debt Does Salvatore Ferragamo Carry?
The image below, which you can click on for greater detail, shows that Salvatore Ferragamo had debt of €80.8m at the end of September 2022, a reduction from €167.2m over a year. However, it does have €433.1m in cash offsetting this, leading to net cash of €352.3m.
How Strong Is Salvatore Ferragamo's Balance Sheet?
We can see from the most recent balance sheet that Salvatore Ferragamo had liabilities of €438.6m falling due within a year, and liabilities of €568.0m due beyond that. Offsetting this, it had €433.1m in cash and €100.2m in receivables that were due within 12 months. So it has liabilities totalling €473.4m more than its cash and near-term receivables, combined.
Of course, Salvatore Ferragamo has a market capitalization of €2.85b, so these liabilities are probably manageable. Having said that, it's clear that we should continue to monitor its balance sheet, lest it change for the worse. While it does have liabilities worth noting, Salvatore Ferragamo also has more cash than debt, so we're pretty confident it can manage its debt safely.
On top of that, Salvatore Ferragamo grew its EBIT by 39% over the last twelve months, and that growth will make it easier to handle its debt. There's no doubt that we learn most about debt from the balance sheet. But it is future earnings, more than anything, that will determine Salvatore Ferragamo'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.
But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. While Salvatore Ferragamo 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, Salvatore Ferragamo actually produced more free cash flow than EBIT over the last two years. That sort of strong cash generation warms our hearts like a puppy in a bumblebee suit.
Summing Up
Although Salvatore Ferragamo's balance sheet isn't particularly strong, due to the total liabilities, it is clearly positive to see that it has net cash of €352.3m. And it impressed us with free cash flow of €300m, being 195% of its EBIT. So is Salvatore Ferragamo's debt a risk? It doesn't seem so to us. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. These risks can be hard to spot. Every company has them, and we've spotted 1 warning sign for Salvatore Ferragamo you should know about.
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.
About BIT:SFER
Salvatore Ferragamo
Through its subsidiaries, creates, produces, and sells luxury goods for men and women in Europe, North America, Japan, the Asia Pacific, and Central and South America.
Excellent balance sheet with reasonable growth potential.
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