Guess? (NYSE:GES) Has A Somewhat Strained Balance Sheet

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. As with many other companies Guess?, Inc. (NYSE:GES) makes use of debt. But the more important question is: how much risk is that debt creating?

Why Does Debt Bring Risk?

Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. If things get really bad, the lenders can take control of the business. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. 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.

See our latest analysis for Guess?

How Much Debt Does Guess? Carry?

You can click the graphic below for the historical numbers, but it shows that as of November 2024 Guess? had US$611.0m of debt, an increase on US$537.3m, over one year. However, because it has a cash reserve of US$140.9m, its net debt is less, at about US$470.1m.

How Strong Is Guess?'s Balance Sheet?

The latest balance sheet data shows that Guess? had liabilities of US$848.8m due within a year, and liabilities of US$1.46b falling due after that. On the other hand, it had cash of US$140.9m and US$383.4m worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by US$1.78b.

The deficiency here weighs heavily on the US$611.3m company itself, as if a child were struggling under the weight of an enormous back-pack full of books, his sports gear, and a trumpet. So we definitely think shareholders need to watch this one closely. After all, Guess? would likely require a major re-capitalisation if it had to pay its creditors today.

We use two main ratios to inform us about debt levels relative to earnings. The first is net debt divided by earnings before interest, tax, depreciation, and amortization (EBITDA), while the second is how many times its earnings before interest and tax (EBIT) covers its interest expense (or its interest cover, for short). The advantage of this approach is that we take into account both the absolute quantum of debt (with net debt to EBITDA) and the actual interest expenses associated with that debt (with its interest cover ratio).

We'd say that Guess?'s moderate net debt to EBITDA ratio ( being 1.6), indicates prudence when it comes to debt. And its strong interest cover of 14.3 times, makes us even more comfortable. On the other hand, Guess? saw its EBIT drop by 5.3% in the last twelve months. That sort of decline, if sustained, will obviously make debt harder to handle. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately the future profitability of the business will decide if Guess? can strengthen its balance sheet over time. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. So we always check how much of that EBIT is translated into free cash flow. Looking at the most recent three years, Guess? recorded free cash flow of 45% of its EBIT, which is weaker than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.

Our View

We'd go so far as to say Guess?'s level of total liabilities was disappointing. But at least it's pretty decent at covering its interest expense with its EBIT; that's encouraging. Looking at the bigger picture, it seems clear to us that Guess?'s use of debt is creating risks for the company. If all goes well, that should boost returns, but on the flip side, the risk of permanent capital loss is elevated by the 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. Be aware that Guess? is showing 3 warning signs in our investment analysis , you should know about...

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.