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, Compagnie Financière Richemont SA (VTX:CFR) does carry debt. But should shareholders be worried about its use of debt?
What Risk Does Debt Bring?
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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.
Our analysis indicates that CFR is potentially overvalued!
How Much Debt Does Compagnie Financière Richemont Carry?
The image below, which you can click on for greater detail, shows that at September 2022 Compagnie Financière Richemont had debt of €11.8b, up from €10.9b in one year. But on the other hand it also has €16.5b in cash, leading to a €4.76b net cash position.
How Healthy Is Compagnie Financière Richemont’s Balance Sheet?
We can see from the most recent balance sheet that Compagnie Financière Richemont had liabilities of €11.8b falling due within a year, and liabilities of €9.55b due beyond that. Offsetting this, it had €16.5b in cash and €1.82b in receivables that were due within 12 months. So its liabilities total €3.02b more than the combination of its cash and short-term receivables.
Of course, Compagnie Financière Richemont has a titanic market capitalization of €71.3b, so these liabilities are probably manageable. Having said that, it’s clear that we should continue to monitor its balance sheet, lest it change for the worse. While it does have liabilities worth noting, Compagnie Financière Richemont also has more cash than debt, so we’re pretty confident it can manage its debt safely.
Also positive, Compagnie Financière Richemont grew its EBIT by 26% in the last year, and that should make it easier to pay down debt, going forward. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Compagnie Financière Richemont’s ability to maintain a healthy balance sheet going forward. 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. Compagnie Financière Richemont 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, Compagnie Financière Richemont 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.
While it is always sensible to look at a company’s total liabilities, it is very reassuring that Compagnie Financière Richemont has €4.76b in net cash. The cherry on top was that in converted 107% of that EBIT to free cash flow, bringing in €3.4b. So is Compagnie Financière Richemont’s debt a risk? It doesn’t seem so to us. Over time, share prices tend to follow earnings per share, so if you’re interested in Compagnie Financière Richemont, you may well want to click here to check an interactive graph of its earnings per share history.
When all is said and done, sometimes its easier to focus on companies that don’t even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.
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Find out whether Compagnie Financière Richemont is potentially over or undervalued by checking out our comprehensive analysis, which includes fair value estimates, risks and warnings, dividends, insider transactions and financial health.
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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.