Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that ‘Volatility is far from synonymous with risk.’ 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. As with many other companies Ralph Lauren Corporation (NYSE:RL) makes use of debt. But is this debt a concern to shareholders?
What Risk Does Debt Bring?
Generally speaking, debt only becomes a real problem when a company can’t easily pay it off, either by raising capital or with its own cash flow. If things get really bad, the lenders can take control of the business. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. 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. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.
Check out the opportunities and risks within the US Luxury industry.
What Is Ralph Lauren’s Net Debt?
You can click the graphic below for the historical numbers, but it shows that Ralph Lauren had US$1.14b of debt in October 2022, down from US$1.63b, one year before. But it also has US$1.42b in cash to offset that, meaning it has US$279.2m net cash.
How Strong Is Ralph Lauren’s Balance Sheet?
Zooming in on the latest balance sheet data, we can see that Ralph Lauren had liabilities of US$1.71b due within 12 months and liabilities of US$2.77b due beyond that. Offsetting these obligations, it had cash of US$1.42b as well as receivables valued at US$626.5m due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by US$2.43b.
Ralph Lauren has a market capitalization of US$7.40b, so it could very likely raise cash to ameliorate its balance sheet, if the need arose. However, it is still worthwhile taking a close look at its ability to pay off debt. While it does have liabilities worth noting, Ralph Lauren also has more cash than debt, so we’re pretty confident it can manage its debt safely.
The good news is that Ralph Lauren has increased its EBIT by 2.3% over twelve months, which should ease any concerns about debt repayment. 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 Ralph Lauren 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.
But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. While Ralph Lauren 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. Over the most recent three years, Ralph Lauren recorded free cash flow worth 70% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This cold hard cash means it can reduce its debt when it wants to.
Although Ralph Lauren’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$279.2m. And it impressed us with free cash flow of US$66m, being 70% of its EBIT. So we are not troubled with Ralph Lauren’s debt use. 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. We’ve identified 2 warning signs with Ralph Lauren (at least 1 which can’t be ignored) , and understanding them should be part of your investment process.
At the end of the day, it’s often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It’s free.
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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.