These 4 Measures Indicate That Levi Strauss (NYSE:LEVI) Is Using Debt Extensively

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. We can see that Levi Strauss & Co. (NYSE:LEVI) does use debt in its business. But the real question is whether this debt is making the company risky.

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. 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. Of course, plenty of companies use debt to fund growth, without any negative consequences. When we examine debt levels, we first consider both cash and debt levels, together.

See our latest analysis for Levi Strauss

What Is Levi Strauss's Net Debt?

You can click the graphic below for the historical numbers, but it shows that as of November 2020 Levi Strauss had US$1.56b of debt, an increase on US$1.01b, over one year. However, it does have US$1.59b in cash offsetting this, leading to net cash of US$29.4m.

How Strong Is Levi Strauss' Balance Sheet?

According to the last reported balance sheet, Levi Strauss had liabilities of US$1.55b due within 12 months, and liabilities of US$2.79b due beyond 12 months. Offsetting this, it had US$1.59b in cash and US$540.2m in receivables that were due within 12 months. So its liabilities total US$2.21b more than the combination of its cash and short-term receivables.

Levi Strauss has a market capitalization of US$9.21b, 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. Despite its noteworthy liabilities, Levi Strauss boasts net cash, so it's fair to say it does not have a heavy debt load!

Importantly, Levi Strauss's EBIT fell a jaw-dropping 73% in the last twelve months. If that decline continues then paying off debt will be harder than selling foie gras at a vegan convention. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Levi Strauss 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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. Levi Strauss 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 most recent three years, Levi Strauss recorded free cash flow worth 68% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This free cash flow puts the company in a good position to pay down debt, when appropriate.

Summing up

While Levi Strauss does have more liabilities than liquid assets, it also has net cash of US$29.4m. The cherry on top was that in converted 68% of that EBIT to free cash flow, bringing in US$339m. So although we see some areas for improvement, we're not too worried about Levi Strauss's balance sheet. 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. For example, we've discovered 2 warning signs for Levi Strauss (1 is a bit concerning!) that you should be aware of before investing here.

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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