We Think Fossil Group (NASDAQ:FOSL) Can Stay On Top Of Its Debt

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.' 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. We note that Fossil Group, Inc. (NASDAQ:FOSL) does have debt on its balance sheet. But the more important question is: how much risk is that debt creating?

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. If things get really bad, the lenders can take control of the business. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. The first step when considering a company's debt levels is to consider its cash and debt together.

View our latest analysis for Fossil Group

What Is Fossil Group's Net Debt?

The image below, which you can click on for greater detail, shows that Fossil Group had debt of US$184.5m at the end of April 2022, a reduction from US$193.8m over a year. However, it also had US$162.6m in cash, and so its net debt is US$21.9m.

How Healthy Is Fossil Group's Balance Sheet?

The latest balance sheet data shows that Fossil Group had liabilities of US$432.7m due within a year, and liabilities of US$403.2m falling due after that. On the other hand, it had cash of US$162.6m and US$201.1m worth of receivables due within a year. So it has liabilities totalling US$472.1m more than its cash and near-term receivables, combined.

Given this deficit is actually higher than the company's market capitalization of US$353.1m, we think shareholders really should watch Fossil Group's debt levels, like a parent watching their child ride a bike for the first time. Hypothetically, extremely heavy dilution would be required if the company were forced to pay down its liabilities by raising capital at the current share price.

In order to size up a company's debt relative to its earnings, we calculate its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and its earnings before interest and tax (EBIT) divided by its interest expense (its interest cover). The advantage of this approach is that we take into account both the absolute quantum of debt (with net debt to EBITDA) and the actual interest expenses associated with that debt (with its interest cover ratio).

Looking at its net debt to EBITDA of 0.15 and interest cover of 5.5 times, it seems to us that Fossil Group is probably using debt in a pretty reasonable way. But the interest payments are certainly sufficient to have us thinking about how affordable its debt is. Pleasingly, Fossil Group is growing its EBIT faster than former Australian PM Bob Hawke downs a yard glass, boasting a 237% gain in the last twelve months. There's no doubt that we learn most about debt from the balance sheet. 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. So the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. During the last two years, Fossil Group produced sturdy free cash flow equating to 65% of its EBIT, about what we'd expect. This cold hard cash means it can reduce its debt when it wants to.

Our View

Fossil Group's EBIT growth rate was a real positive on this analysis, as was its net debt to EBITDA. But truth be told its level of total liabilities had us nibbling our nails. When we consider all the factors mentioned above, we do feel a bit cautious about Fossil Group's use of debt. While we appreciate debt can enhance returns on equity, we'd suggest that shareholders keep close watch on its debt levels, lest they increase. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. For instance, we've identified 2 warning signs for Fossil Group that you should be aware of.

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.