Does H & M Hennes & Mauritz (STO:HM B) Have A Healthy Balance Sheet?

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.' 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, H & M Hennes & Mauritz AB (publ) (STO:HM B) does carry debt. But is this debt a concern to shareholders?

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. 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. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. When we think about a company's use of debt, we first look at cash and debt together.

Check out our latest analysis for H & M Hennes & Mauritz

How Much Debt Does H & M Hennes & Mauritz Carry?

As you can see below, at the end of August 2023, H & M Hennes & Mauritz had kr11.4b of debt, up from kr10.1b a year ago. Click the image for more detail. However, its balance sheet shows it holds kr25.0b in cash, so it actually has kr13.6b net cash.

How Healthy Is H & M Hennes & Mauritz's Balance Sheet?

We can see from the most recent balance sheet that H & M Hennes & Mauritz had liabilities of kr76.9b falling due within a year, and liabilities of kr62.7b due beyond that. Offsetting these obligations, it had cash of kr25.0b as well as receivables valued at kr16.9b due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by kr97.7b.

H & M Hennes & Mauritz has a very large market capitalization of kr266.1b, so it could very likely raise cash to ameliorate its balance sheet, if the need arose. However, it is still worthwhile taking a close look at its ability to pay off debt. While it does have liabilities worth noting, H & M Hennes & Mauritz also has more cash than debt, so we're pretty confident it can manage its debt safely.

In fact H & M Hennes & Mauritz's saving grace is its low debt levels, because its EBIT has tanked 20% in the last twelve months. When it comes to paying off debt, falling earnings are no more useful than sugary sodas are for your health. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine H & M Hennes & Mauritz'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.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. H & M Hennes & Mauritz may have net cash on the balance sheet, but it is still interesting to look at how well the business converts its earnings before interest and tax (EBIT) to free cash flow, because that will influence both its need for, and its capacity to manage debt. Happily for any shareholders, H & M Hennes & Mauritz actually produced more free cash flow than EBIT over the last three years. There's nothing better than incoming cash when it comes to staying in your lenders' good graces.

Summing Up

While H & M Hennes & Mauritz does have more liabilities than liquid assets, it also has net cash of kr13.6b. The cherry on top was that in converted 247% of that EBIT to free cash flow, bringing in kr23b. So we are not troubled with H & M Hennes & Mauritz's debt use. 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. We've identified 2 warning signs with H & M Hennes & Mauritz , and understanding them should be part of your investment process.

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

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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.