David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the 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. As with many other companies Movado Group, Inc. (NYSE:MOV) makes use of debt. But the more important question is: how much risk is that debt creating?
When Is Debt Dangerous?
Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. 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 thing to do when considering how much debt a business uses is to look at its cash and debt together.
What Is Movado Group's Debt?
The chart below, which you can click on for greater detail, shows that Movado Group had US$48.3m in debt in July 2020; about the same as the year before. But on the other hand it also has US$170.5m in cash, leading to a US$122.2m net cash position.
How Healthy Is Movado Group's Balance Sheet?
According to the last reported balance sheet, Movado Group had liabilities of US$109.4m due within 12 months, and liabilities of US$192.6m due beyond 12 months. On the other hand, it had cash of US$170.5m and US$60.1m worth of receivables due within a year. So its liabilities total US$71.4m more than the combination of its cash and short-term receivables.
This deficit isn't so bad because Movado Group is worth US$256.6m, and thus could probably raise enough capital to shore up its balance sheet, if the need arose. However, it is still worthwhile taking a close look at its ability to pay off debt. Despite its noteworthy liabilities, Movado Group boasts net cash, so it's fair to say it does not have a heavy debt load!
In fact Movado Group's saving grace is its low debt levels, because its EBIT has tanked 88% in the last twelve months. Falling earnings (if the trend continues) could eventually make even modest debt quite risky. 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 Movado Group's ability to maintain a healthy balance sheet going forward. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.
Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. Movado 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. Over the last three years, Movado Group recorded free cash flow worth a fulsome 98% of its EBIT, which is stronger than we'd usually expect. That positions it well to pay down debt if desirable to do so.
While Movado Group does have more liabilities than liquid assets, it also has net cash of US$122.2m. And it impressed us with free cash flow of US$45m, being 98% of its EBIT. So we don't have any problem with Movado Group's use of debt. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. Be aware that Movado Group is showing 2 warning signs in our investment analysis , and 1 of those can't be ignored...
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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