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.' 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 FILA Holdings Corporation (KRX:081660) does use debt in its business. 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. 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. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. When we think about a company's use of debt, we first look at cash and debt together.
View our latest analysis for FILA Holdings
What Is FILA Holdings's Net Debt?
The image below, which you can click on for greater detail, shows that FILA Holdings had debt of ₩863.1b at the end of December 2020, a reduction from ₩917.7b over a year. However, because it has a cash reserve of ₩479.3b, its net debt is less, at about ₩383.8b.
A Look At FILA Holdings' Liabilities
According to the last reported balance sheet, FILA Holdings had liabilities of ₩995.5b due within 12 months, and liabilities of ₩905.7b due beyond 12 months. Offsetting these obligations, it had cash of ₩479.3b as well as receivables valued at ₩518.8b due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by ₩903.0b.
FILA Holdings has a market capitalization of ₩2.69t, so it could very likely raise cash to ameliorate its balance sheet, if the need arose. But we definitely want to keep our eyes open to indications that its debt is bringing too much risk.
We use two main ratios to inform us about debt levels relative to earnings. The first is net debt divided by earnings before interest, tax, depreciation, and amortization (EBITDA), while the second is how many times its earnings before interest and tax (EBIT) covers its interest expense (or its interest cover, for short). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.
FILA Holdings has net debt of just 0.87 times EBITDA, indicating that it is certainly not a reckless borrower. And it boasts interest cover of 9.9 times, which is more than adequate. The modesty of its debt load may become crucial for FILA Holdings if management cannot prevent a repeat of the 27% cut to EBIT over the last year. When a company sees its earnings tank, it can sometimes find its relationships with its lenders turn sour. 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 FILA Holdings can strengthen its balance sheet over time. So if you're focused on the future you can check out this free report showing analyst profit forecasts.
Finally, a company can only pay off debt with cold hard cash, not accounting profits. So we always check how much of that EBIT is translated into free cash flow. During the last three years, FILA Holdings produced sturdy free cash flow equating to 72% 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.
Our View
FILA Holdings's EBIT growth rate was a real negative on this analysis, although the other factors we considered were considerably better. In particular, we are dazzled with its conversion of EBIT to free cash flow. Looking at all this data makes us feel a little cautious about FILA Holdings's debt levels. While we appreciate debt can enhance returns on equity, we'd suggest that shareholders keep close watch on its debt levels, lest they increase. 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. For example - FILA Holdings has 2 warning signs we think you should be aware of.
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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About KOSE:A081660
FILA Holdings
Engages in the sale of textile products, clothing, footwear, leather products, watches, cosmetics, golf equipment, and other products under the FILA brand name in Korea and internationally.
Flawless balance sheet and fair value.
