Is Skyline Champion (NYSE:SKY) A Risky Investment?

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.' 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 can see that Skyline Champion Corporation (NYSE:SKY) does use debt in its business. But the more important question is: how much risk is that debt creating?

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 frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. Of course, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. The first step when considering a company's debt levels is to consider its cash and debt together.

See our latest analysis for Skyline Champion

What Is Skyline Champion's Net Debt?

The image below, which you can click on for greater detail, shows that Skyline Champion had debt of US$68.1m at the end of July 2021, a reduction from US$106.7m over a year. However, its balance sheet shows it holds US$287.7m in cash, so it actually has US$219.6m net cash.

How Strong Is Skyline Champion's Balance Sheet?

According to the last reported balance sheet, Skyline Champion had liabilities of US$288.4m due within 12 months, and liabilities of US$85.4m due beyond 12 months. Offsetting these obligations, it had cash of US$287.7m as well as receivables valued at US$60.5m due within 12 months. So its liabilities total US$25.5m more than the combination of its cash and short-term receivables.

Having regard to Skyline Champion's size, it seems that its liquid assets are well balanced with its total liabilities. So it's very unlikely that the US$3.75b company is short on cash, but still worth keeping an eye on the balance sheet. While it does have liabilities worth noting, Skyline Champion also has more cash than debt, so we're pretty confident it can manage its debt safely.

In addition to that, we're happy to report that Skyline Champion has boosted its EBIT by 95%, thus reducing the spectre of future debt repayments. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately the future profitability of the business will decide if Skyline Champion 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.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. Skyline Champion 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 two years, Skyline Champion recorded free cash flow worth a fulsome 90% of its EBIT, which is stronger than we'd usually expect. That puts it in a very strong position to pay down debt.

Summing up

We could understand if investors are concerned about Skyline Champion's liabilities, but we can be reassured by the fact it has has net cash of US$219.6m. The cherry on top was that in converted 90% of that EBIT to free cash flow, bringing in US$138m. So we don't think Skyline Champion's use of debt is risky. 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. Case in point: We've spotted 1 warning sign for Skyline Champion you should be aware of.

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

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.

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