Is Signet Jewelers (NYSE:SIG) A Risky Investment?

Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. Importantly, Signet Jewelers Limited (NYSE:SIG) does carry debt. But the more important question is: how much risk is that debt creating?

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. When we think about a company's use of debt, we first look at cash and debt together.

Check out our latest analysis for Signet Jewelers

What Is Signet Jewelers's Debt?

The chart below, which you can click on for greater detail, shows that Signet Jewelers had US$147.5m in debt in July 2023; about the same as the year before. But it also has US$690.2m in cash to offset that, meaning it has US$542.7m net cash.

How Strong Is Signet Jewelers' Balance Sheet?

We can see from the most recent balance sheet that Signet Jewelers had liabilities of US$1.85b falling due within a year, and liabilities of US$1.97b due beyond that. Offsetting this, it had US$690.2m in cash and US$26.3m in receivables that were due within 12 months. So its liabilities total US$3.10b more than the combination of its cash and short-term receivables.

This is a mountain of leverage relative to its market capitalization of US$3.14b. This suggests shareholders would be heavily diluted if the company needed to shore up its balance sheet in a hurry. While it does have liabilities worth noting, Signet Jewelers also has more cash than debt, so we're pretty confident it can manage its debt safely.

But the bad news is that Signet Jewelers has seen its EBIT plunge 15% in the last twelve months. If that rate of decline in earnings continues, the company could find itself in a tight spot. 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 Signet Jewelers'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.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. Signet Jewelers 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. Happily for any shareholders, Signet Jewelers actually produced more free cash flow than EBIT over the last three years. That sort of strong cash conversion gets us as excited as the crowd when the beat drops at a Daft Punk concert.

Summing Up

Although Signet Jewelers'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$542.7m. The cherry on top was that in converted 122% of that EBIT to free cash flow, bringing in US$523m. So we don't have any problem with Signet Jewelers's use of debt. 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. Case in point: We've spotted 1 warning sign for Signet Jewelers you should be aware of.

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.