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.' 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. We can see that Signet Jewelers Limited (NYSE:SIG) does use debt in its business. But the real question is whether this debt is making the company risky.
When Is Debt A Problem?
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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. 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.
How Much Debt Does Signet Jewelers Carry?
As you can see below, Signet Jewelers had US$147.2m of debt, at July 2022, which is about the same as the year before. You can click the chart for greater detail. However, it does have US$851.7m in cash offsetting this, leading to net cash of US$704.5m.
A Look At Signet Jewelers' Liabilities
We can see from the most recent balance sheet that Signet Jewelers had liabilities of US$1.92b falling due within a year, and liabilities of US$2.22b due beyond that. Offsetting these obligations, it had cash of US$851.7m as well as receivables valued at US$154.1m due within 12 months. So its liabilities total US$3.14b more than the combination of its cash and short-term receivables.
Given this deficit is actually higher than the company's market capitalization of US$2.58b, we think shareholders really should watch Signet Jewelers's debt levels, like a parent watching their child ride a bike for the first time. 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. Given that Signet Jewelers has more cash than debt, we're pretty confident it can handle its debt, despite the fact that it has a lot of liabilities in total.
Fortunately, Signet Jewelers grew its EBIT by 8.5% in the last year, making that debt load look even more manageable. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Signet Jewelers 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. 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. Over the last three years, Signet Jewelers actually produced more free cash flow than EBIT. That sort of strong cash conversion gets us as excited as the crowd when the beat drops at a Daft Punk concert.
While Signet Jewelers does have more liabilities than liquid assets, it also has net cash of US$704.5m. And it impressed us with free cash flow of US$528m, being 158% of its EBIT. So we are not troubled with Signet Jewelers's debt use. 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. We've identified 4 warning signs with Signet Jewelers (at least 1 which is potentially serious) , and understanding them should be part of your investment process.
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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Signet Jewelers Limited operates as a diamond jewelry retailer.
The Snowflake is a visual investment summary with the score of each axis being calculated by 6 checks in 5 areas.
|Analysis Area||Score (0-6)|
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Flawless balance sheet and good value.