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.' 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 Dillard's, Inc. (NYSE:DDS) does use debt in its business. But is this debt a concern to shareholders?
When Is Debt A Problem?
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. The first step when considering a company's debt levels is to consider its cash and debt together.
How Much Debt Does Dillard's Carry?
The chart below, which you can click on for greater detail, shows that Dillard's had US$566.1m in debt in January 2022; about the same as the year before. But on the other hand it also has US$716.8m in cash, leading to a US$150.7m net cash position.
How Healthy Is Dillard's' Balance Sheet?
Zooming in on the latest balance sheet data, we can see that Dillard's had liabilities of US$966.2m due within 12 months and liabilities of US$828.2m due beyond that. Offsetting these obligations, it had cash of US$716.8m as well as receivables valued at US$39.8m due within 12 months. So it has liabilities totalling US$1.04b more than its cash and near-term receivables, combined.
Since publicly traded Dillard's shares are worth a total of US$5.40b, it seems unlikely that this level of liabilities would be a major threat. Having said that, it's clear that we should continue to monitor its balance sheet, lest it change for the worse. Despite its noteworthy liabilities, Dillard's boasts net cash, so it's fair to say it does not have a heavy debt load!
Although Dillard's made a loss at the EBIT level, last year, it was also good to see that it generated US$1.1b in EBIT over the last twelve months. There's no doubt that we learn most about debt from the balance sheet. But ultimately the future profitability of the business will decide if Dillard's 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. Dillard's 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 year, Dillard's actually produced more free cash flow than EBIT. There's nothing better than incoming cash when it comes to staying in your lenders' good graces.
Although Dillard's's balance sheet isn't particularly strong, due to the total liabilities, it is clearly positive to see that it has net cash of US$150.7m. And it impressed us with free cash flow of US$1.2b, being 105% of its EBIT. So we don't think Dillard's'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. For instance, we've identified 1 warning sign for Dillard's that 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.
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.