Warren Buffett said: “Volatility is far from synonymous with risk. So it seems smart money knows that debt – which is usually involved in bankruptcies – is a very important factor when you’re assessing a company’s risk. Mostly, Shoe Zone plc (LON:SHOE) is in debt. But the real question is whether this debt makes the business risky.
Why is debt risky?
Generally speaking, debt only becomes a real problem when a company cannot easily repay it, either by raising capital or with its own cash flow. Ultimately, if the company cannot meet its legal debt repayment obligations, shareholders could walk away with nothing. Although not too common, we often see companies in debt permanently diluting their shareholders because lenders force them to raise capital at a ridiculous price. By replacing dilution, however, debt can be a great tool for companies that need capital to invest in growth at high rates of return. The first step when considering a company’s debt levels is to consider its cash and debt together.
See our latest review for Shoe Zone
What is Shoe Zone’s debt?
As you can see below, Shoe Zone had a debt of £4.40m in October 2021, up from £7.00m the previous year. However, he has £19.0m in cash to offset this, which translates to a net cash of £14.6m.
How strong is Shoe Zone’s balance sheet?
Zooming in on the latest balance sheet data, we can see that Shoe Zone had liabilities of £40.9m due within 12 months and liabilities of £33.6m due beyond. In return, he had £19.0 million in cash and £2.05 million in debt due within 12 months. It therefore has liabilities totaling £53.5m more than its cash and short-term receivables, combined.
This shortfall is sizable compared to its market capitalization of £61.2m, so it suggests shareholders should monitor Shoe Zone’s use of debt. This suggests shareholders would be heavily diluted if the company needed to shore up its balance sheet quickly. While he has liabilities to note, Shoe Zone also has more cash than debt, so we’re pretty confident he can manage his debt safely.
Although Shoe Zone had a loss in EBIT last year, it was also good to see that it generated £13m of EBIT in the last twelve months. When analyzing debt levels, the balance sheet is the obvious starting point. But ultimately, the company’s future profitability will decide whether Shoe Zone can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free analyst earnings forecast report interesting.
But our last consideration is also important, because a company cannot pay debt with paper profits; he needs cash. Although Shoe Zone has net cash on its balance sheet, it’s still worth looking at its ability to convert earnings before interest and taxes (EBIT) to free cash flow, to help us understand how quickly it’s building ( or erodes) that money. balance. Fortunately for all shareholders, Shoe Zone has actually produced more free cash flow than EBIT over the past year. This kind of high cash conversion gets us as excited as the crowd when the beat drops at a Daft Punk concert.
Although Shoe Zone’s balance sheet is not particularly strong, due to total liabilities, it is clearly positive to see that it has a net cash position of £14.6m. The icing on the cake was converting 215% of that EBIT into free cash flow, which brought in £29m. So we have no problem with Shoe Zone’s use of debt. There is no doubt that we learn the most about debt from the balance sheet. However, not all investment risks reside on the balance sheet, far from it. For example, we have identified 4 warning signs for Shoe Zone (1 doesn’t sit too well with us) you should know.
In the end, it’s often best to focus on companies that aren’t in debt. You can access our special list of these companies (all with a track record of earnings growth). It’s free.
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This Simply Wall St article is general in nature. We provide commentary based on historical data and analyst forecasts only using unbiased methodology and our articles are not intended to be financial advice. It is not a recommendation to buy or sell stocks and does not take into account your objectives or financial situation. Our goal is to bring you targeted long-term analysis based on fundamental data. Note that our analysis may not take into account the latest announcements from price-sensitive companies or qualitative materials. Simply Wall St has no position in the stocks mentioned.