The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. As with many other companies Kontoor Brands, Inc. (NYSE:KTB) makes use of debt. But the more important question is: how much risk is that debt creating?

What Risk Does Debt Bring?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. When we examine debt levels, we first consider both cash and debt levels, together.

How Much Debt Does Kontoor Brands Carry?

As you can see below, Kontoor Brands had US$749.7m of debt at June 2024, down from US$788.3m a year prior. However, because it has a cash reserve of US$224.3m, its net debt is less, at about US$525.4m.

A Look At Kontoor Brands' Liabilities

The latest balance sheet data shows that Kontoor Brands had liabilities of US$373.1m due within a year, and liabilities of US$872.2m falling due after that. Offsetting this, it had US$224.3m in cash and US$212.8m in receivables that were due within 12 months. So its liabilities total US$808.2m more than the combination of its cash and short-term receivables.

Since publicly traded Kontoor Brands shares are worth a total of US$4.56b, it seems unlikely that this level of liabilities would be a major threat. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time.

We use two main ratios to inform us about debt levels relative to earnings. The first is net debt divided by earnings before interest, tax, depreciation, and amortization (EBITDA), while the second is how many times its earnings before interest and tax (EBIT) covers its interest expense (or its interest cover, for short). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

Kontoor Brands has a low net debt to EBITDA ratio of only 1.4. And its EBIT covers its interest expense a whopping 10.2 times over. So we're pretty relaxed about its super-conservative use of debt. On the other hand, Kontoor Brands saw its EBIT drop by 2.3% in the last twelve months. That sort of decline, if sustained, will obviously make debt harder to handle. There's no doubt that we learn most about debt from the balance sheet. But it is future earnings, more than anything, that will determine Kontoor Brands's ability to maintain a healthy balance sheet going forward. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. During the last three years, Kontoor Brands produced sturdy free cash flow equating to 65% of its EBIT, about what we'd expect. This free cash flow puts the company in a good position to pay down debt, when appropriate.

Our View

Happily, Kontoor Brands's impressive interest cover implies it has the upper hand on its debt. But, on a more sombre note, we are a little concerned by its EBIT growth rate. All these things considered, it appears that Kontoor Brands can comfortably handle its current debt levels. On the plus side, this leverage can boost shareholder returns, but the potential downside is more risk of loss, so it's worth monitoring the balance sheet. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. For example - Kontoor Brands has 2 warning signs we think you should be aware of.

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

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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.