David Iben put it well when he said, ‘Volatility is not a risk we care about. What we care about is avoiding the 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. Importantly, Christian Dior SE (EPA:CDI) does carry debt. But the real question is whether this debt is making the company risky.
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. If things get really bad, the lenders can take control of the business. 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. The first step when considering a company’s debt levels is to consider its cash and debt together.
See our latest analysis for Christian Dior
What Is Christian Dior’s Debt?
As you can see below, Christian Dior had €21.6b of debt at June 2022, down from €24.1b a year prior. On the flip side, it has €8.08b in cash leading to net debt of about €13.5b.
How Healthy Is Christian Dior’s Balance Sheet?
The latest balance sheet data shows that Christian Dior had liabilities of €32.0b due within a year, and liabilities of €46.2b falling due after that. Offsetting these obligations, it had cash of €8.08b as well as receivables valued at €4.61b due within 12 months. So its liabilities total €65.5b more than the combination of its cash and short-term receivables.
This deficit isn’t so bad because Christian Dior is worth a massive €120.4b, and thus could probably raise enough capital to shore up its balance sheet, if the need arose. But we definitely want to keep our eyes open to indications that its debt is bringing too much risk.
In order to size up a company’s debt relative to its earnings, we calculate its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and its earnings before interest and tax (EBIT) divided by its interest expense (its interest cover). The advantage of this approach is that we take into account both the absolute quantum of debt (with net debt to EBITDA) and the actual interest expenses associated with that debt (with its interest cover ratio).
Christian Dior has a low net debt to EBITDA ratio of only 0.62. And its EBIT easily covers its interest expense, being 108 times the size. So we’re pretty relaxed about its super-conservative use of debt. In addition to that, we’re happy to report that Christian Dior has boosted its EBIT by 36%, thus reducing the spectre of future debt repayments. The balance sheet is clearly the area to focus on when you are analysing debt. But it is Christian Dior’s earnings that will influence how the balance sheet holds up in the future. So when considering debt, it’s definitely worth looking at the earnings trend. Click here for an interactive snapshot.
Finally, a company can only pay off debt with cold hard cash, not accounting profits. So we always check how much of that EBIT is translated into free cash flow. Over the last three years, Christian Dior recorded free cash flow worth a fulsome 85% of its EBIT, which is stronger than we’d usually expect. That positions it well to pay down debt if desirable to do so.
Happily, Christian Dior’s impressive interest cover implies it has the upper hand on its debt. But truth be told we feel its level of total liabilities does undermine this impression a bit. Looking at the bigger picture, we think Christian Dior’s use of debt seems quite reasonable and we’re not concerned about it. While debt does bring risk, when used wisely it can also bring a higher return on equity. Over time, share prices tend to follow earnings per share, so if you’re interested in Christian Dior, you may well want to click here to check an interactive graph of its earnings per share history.
If you’re interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.
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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.