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

The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' 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. Importantly, Skyline Champion Corporation (NYSE:SKY) does carry debt. But should shareholders be worried about its use of debt?

Why Does Debt Bring Risk?

Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we examine debt levels, we first consider both cash and debt levels, together.

View 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 as of March 2024 Skyline Champion had US$116.0m of debt, an increase on US$12.4m, over one year. However, its balance sheet shows it holds US$495.1m in cash, so it actually has US$379.1m net cash.

How Strong Is Skyline Champion's Balance Sheet?

We can see from the most recent balance sheet that Skyline Champion had liabilities of US$389.6m falling due within a year, and liabilities of US$111.4m due beyond that. Offsetting this, it had US$495.1m in cash and US$64.6m in receivables that were due within 12 months. So it actually has US$58.7m more liquid assets than total liabilities.

This state of affairs indicates that Skyline Champion's balance sheet looks quite solid, as its total liabilities are just about equal to its liquid assets. So while it's hard to imagine that the US$4.01b company is struggling for cash, we still think it's worth monitoring its balance sheet. Succinctly put, Skyline Champion boasts net cash, so it's fair to say it does not have a heavy debt load!

In fact Skyline Champion's saving grace is its low debt levels, because its EBIT has tanked 66% 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 Skyline Champion'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 company can only pay off debt with cold hard cash, not accounting profits. 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 71% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This cold hard cash means it can reduce its debt when it wants to.

Summing Up

While it is always sensible to investigate a company's debt, in this case Skyline Champion has US$379.1m in net cash and a decent-looking balance sheet. And it impressed us with free cash flow of US$170m, being 71% of its EBIT. So we are not troubled with Skyline Champion's debt use. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. For example - Skyline Champion has 2 warning signs we think you should be aware of.

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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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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team@simplywallst.com