Is Skyline Champion (NYSE:SKY) Using Too Much Debt?

Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. As with many other companies Skyline Champion Corporation (NYSE:SKY) makes use of debt. But the more important question is: how much risk is that debt creating?

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. 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. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. 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?

You can click the graphic below for the historical numbers, but it shows that Skyline Champion had US$12.4m of debt in December 2022, down from US$46.7m, one year before. But it also has US$712.4m in cash to offset that, meaning it has US$700.0m net cash.

How Strong Is Skyline Champion's Balance Sheet?

The latest balance sheet data shows that Skyline Champion had liabilities of US$260.3m due within a year, and liabilities of US$78.0m falling due after that. Offsetting this, it had US$712.4m in cash and US$47.5m in receivables that were due within 12 months. So it can boast US$421.7m more liquid assets than total liabilities.

This surplus suggests that Skyline Champion has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Succinctly put, Skyline Champion boasts net cash, so it's fair to say it does not have a heavy debt load!

Better yet, Skyline Champion grew its EBIT by 115% last year, which is an impressive improvement. That boost will make it even easier to pay down debt going forward. 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 want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. While Skyline Champion has net cash on its balance sheet, it's still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. Over the most recent three years, Skyline Champion recorded free cash flow worth 73% 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 it is always sensible to investigate a company's debt, in this case Skyline Champion has US$700.0m in net cash and a decent-looking balance sheet. And it impressed us with its EBIT growth of 115% over the last year. So is Skyline Champion's debt a risk? It doesn't seem so to us. 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 2 warning signs for Skyline Champion you should be aware of, and 1 of them can't be ignored.

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.

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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.