Here's Why Dillard's (NYSE:DDS) Can Manage Its Debt Responsibly

Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that '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. Importantly, Dillard's, Inc. (NYSE:DDS) does carry debt. But the real question is whether this debt is making the company risky.

Why Does Debt Bring Risk?

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

See our latest analysis for Dillard's

What Is Dillard's's Debt?

The image below, which you can click on for greater detail, shows that Dillard's had debt of US$521.4m at the end of October 2023, a reduction from US$566.1m over a year. But it also has US$893.3m in cash to offset that, meaning it has US$371.9m net cash.

A Look At Dillard's' Liabilities

Zooming in on the latest balance sheet data, we can see that Dillard's had liabilities of US$1.20b due within 12 months and liabilities of US$882.1m due beyond that. Offsetting this, it had US$893.3m in cash and US$57.4m in receivables that were due within 12 months. So its liabilities total US$1.13b more than the combination of its cash and short-term receivables.

Since publicly traded Dillard's shares are worth a total of US$5.68b, 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!

In fact Dillard's's saving grace is its low debt levels, because its EBIT has tanked 20% in the last twelve months. Falling earnings (if the trend continues) could eventually make even modest debt quite risky. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Dillard's'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.

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 three years, Dillard's 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.

Summing Up

While Dillard's does have more liabilities than liquid assets, it also has net cash of US$371.9m. And it impressed us with free cash flow of US$707m, being 89% of its EBIT. So we don't have any problem with Dillard's's use of debt. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. To that end, you should be aware of the 1 warning sign we've spotted with Dillard's .

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.