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.' 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 Genesco Inc. (NYSE:GCO) does use debt in its business. But should shareholders be worried about its use of debt?
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. 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. 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. When we examine debt levels, we first consider both cash and debt levels, together.
What Is Genesco's Debt?
The image below, which you can click on for greater detail, shows that Genesco had debt of US$32.9m at the end of October 2020, a reduction from US$79.5m over a year. However, it does have US$115.1m in cash offsetting this, leading to net cash of US$82.2m.
How Healthy Is Genesco's Balance Sheet?
Zooming in on the latest balance sheet data, we can see that Genesco had liabilities of US$432.6m due within 12 months and liabilities of US$633.9m due beyond that. Offsetting this, it had US$115.1m in cash and US$35.6m in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by US$915.9m.
When you consider that this deficiency exceeds the company's US$701.0m market capitalization, you might well be inclined to review the balance sheet intently. Hypothetically, extremely heavy dilution would be required if the company were forced to pay down its liabilities by raising capital at the current share price. Genesco boasts net cash, so it's fair to say it does not have a heavy debt load, even if it does have very significant liabilities, in total. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Genesco'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.
Over 12 months, Genesco made a loss at the EBIT level, and saw its revenue drop to US$1.8b, which is a fall of 17%. That's not what we would hope to see.
So How Risky Is Genesco?
While Genesco lost money on an earnings before interest and tax (EBIT) level, it actually generated positive free cash flow US$139m. So taking that on face value, and considering the net cash situation, we don't think that the stock is too risky in the near term. Given the lack of transparency around future revenue (and cashflow), we're nervous about this one, until it makes its first big sales. To us, it is a high risk play. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. Be aware that Genesco is showing 2 warning signs in our investment analysis , you should know about...
If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.
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