Is Fossil Group (NASDAQ:FOSL) A Risky Investment?

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. As with many other companies Fossil Group, Inc. (NASDAQ:FOSL) makes use of debt. But is this debt a concern to shareholders?

When Is Debt Dangerous?

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 common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

See our latest analysis for Fossil Group

How Much Debt Does Fossil Group Carry?

As you can see below, Fossil Group had US$137.8m of debt at October 2021, down from US$237.5m a year prior. But it also has US$181.8m in cash to offset that, meaning it has US$44.0m net cash.

How Strong Is Fossil Group's Balance Sheet?

According to the last reported balance sheet, Fossil Group had liabilities of US$569.4m due within 12 months, and liabilities of US$343.7m due beyond 12 months. On the other hand, it had cash of US$181.8m and US$251.5m worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by US$479.8m.

This deficit is considerable relative to its market capitalization of US$523.5m, so it does suggest shareholders should keep an eye on Fossil Group's use of debt. This suggests shareholders would be heavily diluted if the company needed to shore up its balance sheet in a hurry. While it does have liabilities worth noting, Fossil Group also has more cash than debt, so we're pretty confident it can manage its debt safely.

We also note that Fossil Group improved its EBIT from a last year's loss to a positive US$106m. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since Fossil Group will need earnings to service that debt. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. Fossil Group 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. During the last year, Fossil Group burned a lot of cash. While investors are no doubt expecting a reversal of that situation in due course, it clearly does mean its use of debt is more risky.

Summing up

While Fossil Group does have more liabilities than liquid assets, it also has net cash of US$44.0m. Despite the cash, we do find Fossil Group's conversion of EBIT to free cash flow concerning, so we're not particularly comfortable with the stock. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. We've identified 3 warning signs with Fossil Group , and understanding them should be part of your investment process.

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.