Is Ermenegildo Zegna (NYSE:ZGN) A Risky Investment?

Warren Buffett famously said, 'Volatility is far from synonymous with risk.' 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. We note that Ermenegildo Zegna N.V. (NYSE:ZGN) does have debt on its balance sheet. But is this debt a concern to shareholders?

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. 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. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. The first step when considering a company's debt levels is to consider its cash and debt together.

View our latest analysis for Ermenegildo Zegna

What Is Ermenegildo Zegna's Debt?

As you can see below, Ermenegildo Zegna had €403.5m of debt at December 2023, down from €473.4m a year prior. However, because it has a cash reserve of €386.3m, its net debt is less, at about €17.2m.

A Look At Ermenegildo Zegna's Liabilities

We can see from the most recent balance sheet that Ermenegildo Zegna had liabilities of €1.01b falling due within a year, and liabilities of €854.0m due beyond that. Offsetting this, it had €386.3m in cash and €271.5m in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by €1.21b.

This deficit isn't so bad because Ermenegildo Zegna is worth €2.81b, and thus could probably raise enough capital to shore up 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. Carrying virtually no net debt, Ermenegildo Zegna has a very light debt load indeed.

In order to size up a company's debt relative to its earnings, we calculate its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and its earnings before interest and tax (EBIT) divided by its interest expense (its interest cover). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

Ermenegildo Zegna has very modest net debt, giving rise to a debt to EBITDA ratio of 0.059. And EBIT easily covered the interest expense 8.1 times over, lending force to that view. In addition to that, we're happy to report that Ermenegildo Zegna has boosted its EBIT by 43%, thus reducing the spectre of future debt repayments. 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 Ermenegildo Zegna's ability to maintain a healthy balance sheet going forward. 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. So the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. Over the last three years, Ermenegildo Zegna recorded free cash flow worth a fulsome 89% of its EBIT, which is stronger than we'd usually expect. That positions it well to pay down debt if desirable to do so.

Our View

The good news is that Ermenegildo Zegna's demonstrated ability to convert EBIT to free cash flow delights us like a fluffy puppy does a toddler. And that's just the beginning of the good news since its EBIT growth rate is also very heartening. Zooming out, Ermenegildo Zegna seems to use debt quite reasonably; and that gets the nod from us. After all, sensible leverage can boost returns on equity. Over time, share prices tend to follow earnings per share, so if you're interested in Ermenegildo Zegna, you may well want to click here to check an interactive graph of its earnings per share history.

When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.

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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.