David Iben put it well when he said: “Volatility is not a risk we care about. What matters to us is to avoid the permanent loss of capital. ‘ When we think about how risky a business is, we always like to look at its use of debt because debt overload can lead to bankruptcy. We can see that Ralph Lauren Company (NYSE: RL) uses debt in its business. But should shareholders be concerned about its use of debt?
When Is Debt a Problem?
Debt helps a business until the business struggles to repay it, either with new capital or with free cash flow. In the worst case scenario, a business can go bankrupt if it cannot pay its creditors. While it’s not too common, we often see indebted companies continually diluting their shareholders because lenders are forcing them to raise capital at a ridiculous price. That said, the most common situation is where a business manages its debt reasonably well – and to its own advantage. The first step in examining a company’s debt levels is to consider its cash flow and debt together.
See our latest review for Ralph Lauren
How much debt does Ralph Lauren carry?
You can click on the graph below for historical figures, but it shows Ralph Lauren owed $ 1.63 billion in debt as of June 2021, down from $ 1.93 billion a year earlier. However, it has US $ 2.96 billion in cash offsetting this, leading to net cash of US $ 1.33 billion.
How strong is Ralph Lauren’s balance sheet?
Zooming in on the latest balance sheet data, we can see that Ralph Lauren had a liability of US $ 2.11 billion owed within 12 months and a liability of US $ 3.13 billion owed beyond that. On the other hand, he had $ 2.96 billion in cash and $ 498.0 million in receivables due within a year. As a result, its liabilities exceed the sum of its cash and (short-term) receivables by US $ 1.78 billion.
Given that Ralph Lauren has a market cap of US $ 9.05 billion, it’s hard to believe that these liabilities pose a big threat. However, we think it’s worth keeping an eye on the strength of its balance sheet as it can change over time. Despite his notable liabilities, Ralph Lauren has a net cash flow, so it’s fair to say that he doesn’t have a lot of debt!
Even more impressive was the fact that Ralph Lauren increased its EBIT by 138% year over year. This boost will make it even easier to pay down debt in the future. There is no doubt that we learn the most about debt from the balance sheet. But it is future profits, more than anything, that will determine Ralph Lauren’s ability to maintain a healthy balance sheet going forward. So if you are focused on the future you can check out this free report showing analysts’ earnings forecasts.
Finally, while the IRS may love accounting profits, lenders only accept hard cash. While Ralph Lauren has net cash on its balance sheet, it’s still worth looking at its ability to convert earnings before interest and taxes (EBIT) into free cash flow, to help us understand how fast it’s building ( or erodes) that cash. balance. Over the past three years, Ralph Lauren has generated free cash flow amounting to a very solid 86% of its EBIT, more than we expected. This puts him in a very strong position to pay off the debt.
Although Ralph Lauren has more liabilities than liquid assets, it also has net cash of $ 1.33 billion. The icing on the cake is that he converted 86% of that EBIT to free cash flow, bringing in US $ 584 million. So we don’t think Ralph Lauren’s use of debt is risky. There is no doubt that we learn the most about debt from the balance sheet. However, not all investment risks lie on the balance sheet – far from it. We have identified 3 warning signs with Ralph Lauren, and understanding them should be part of your investment process.
If, after all of this, you’re more interested in a fast-growing company with a strong balance sheet, take a quick look at our list of cash net growth stocks.
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