Salvatore Ferragamo (BIT:SFER) Seems To Use Debt Rather Sparingly

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.' 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 can see that Salvatore Ferragamo S.p.A. (BIT:SFER) does use debt in its business. But is this debt a concern to shareholders?

When Is Debt A Problem?

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 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. 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. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

Check out 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 €97.0m at the end of March 2022, a reduction from €172.1m over a year. However, its balance sheet shows it holds €455.6m in cash, so it actually has €358.6m net cash.

How Strong Is Salvatore Ferragamo's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Salvatore Ferragamo had liabilities of €415.3m due within 12 months and liabilities of €576.7m due beyond that. Offsetting this, it had €455.6m in cash and €125.5m in receivables that were due within 12 months. So its liabilities total €411.0m more than the combination of its cash and short-term receivables.

Since publicly traded Salvatore Ferragamo shares are worth a total of €2.37b, it seems unlikely that this level of liabilities would be a major threat. 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.

Better yet, Salvatore Ferragamo grew its EBIT by 1,232% last year, which is an impressive improvement. That boost will make it even easier to pay down debt going forward. 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. Over the last three years, Salvatore Ferragamo actually produced more free cash flow than EBIT. There's nothing better than incoming cash when it comes to staying in your lenders' good graces.

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 €358.6m. The cherry on top was that in converted 218% of that EBIT to free cash flow, bringing in €307m. 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. But ultimately, every company can contain risks that exist outside of the balance sheet. For instance, we've identified 2 warning signs for Salvatore Ferragamo that you should be aware of.

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.