We Think Signet Jewelers (NYSE:SIG) Can Stay On Top Of Its Debt

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 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 Signet Jewelers Limited (NYSE:SIG) does use debt in its business. But the more important question is: how much risk is that debt creating?

When Is Debt A Problem?

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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. Of course, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. When we think about a company's use of debt, we first look at cash and debt together.

See our latest analysis for Signet Jewelers

What Is Signet Jewelers's Debt?

As you can see below, Signet Jewelers had US$147.5m of debt, at April 2023, which is about the same as the year before. You can click the chart for greater detail. However, its balance sheet shows it holds US$655.9m in cash, so it actually has US$508.4m net cash.

How Healthy Is Signet Jewelers' Balance Sheet?

We can see from the most recent balance sheet that Signet Jewelers had liabilities of US$1.78b falling due within a year, and liabilities of US$2.19b due beyond that. On the other hand, it had cash of US$655.9m and US$65.2m worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by US$3.25b.

Given this deficit is actually higher than the company's market capitalization of US$3.20b, 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. Signet Jewelers 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.

On the other hand, Signet Jewelers saw its EBIT drop by 4.8% 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 Signet Jewelers 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. While Signet Jewelers has net cash on its balance sheet, it's still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. 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

While Signet Jewelers does have more liabilities than liquid assets, it also has net cash of US$508.4m. And it impressed us with free cash flow of US$406m, being 133% of its EBIT. So we don't have any problem with Signet Jewelers's use of debt. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. For example, we've discovered 1 warning sign for Signet Jewelers that you should be aware of before investing here.

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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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.