Is H & M Hennes & Mauritz (STO:HM B) A Risky Investment?

Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' So it seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. As with many other companies H & M Hennes & Mauritz AB (publ) (STO:HM B) makes use of debt. But the real question is whether this debt is making the company risky.

Why Does Debt Bring Risk?

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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. 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 H & M Hennes & Mauritz

What Is H & M Hennes & Mauritz's Debt?

You can click the graphic below for the historical numbers, but it shows that as of November 2022 H & M Hennes & Mauritz had kr10.8b of debt, an increase on kr9.61b, over one year. But it also has kr21.7b in cash to offset that, meaning it has kr10.9b 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 kr68.3b falling due within a year, and liabilities of kr63.0b due beyond that. Offsetting this, it had kr21.7b in cash and kr10.1b in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by kr99.4b.

This deficit isn't so bad because H & M Hennes & Mauritz is worth a massive kr211.1b, and thus could probably raise enough capital to shore up 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. Despite its noteworthy liabilities, H & M Hennes & Mauritz boasts net cash, so it's fair to say it does not have a heavy debt load!

In fact H & M Hennes & Mauritz's saving grace is its low debt levels, because its EBIT has tanked 53% 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. The balance sheet is clearly the area to focus on when you are analysing debt. 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, a company can only pay off debt with cold hard cash, not accounting profits. 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. Over the last three years, H & M Hennes & Mauritz actually produced more free cash flow than EBIT. That sort of strong cash generation warms our hearts like a puppy in a bumblebee suit.

Summing Up

Although H & M Hennes & Mauritz's balance sheet isn't particularly strong, due to the total liabilities, it is clearly positive to see that it has net cash of kr10.9b. And it impressed us with free cash flow of kr18b, being 315% of its EBIT. So we are not troubled with H & M Hennes & Mauritz's debt use. There's no doubt that we learn most about debt from the balance sheet. 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.

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.