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.' 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, V.F. Corporation (NYSE:VFC) does carry debt. But is this debt a concern to shareholders?

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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

What Is V.F's Net Debt?

The image below, which you can click on for greater detail, shows that V.F had debt of US$5.95b at the end of March 2024, a reduction from US$6.63b over a year. However, it also had US$676.9m in cash, and so its net debt is US$5.27b.

How Healthy Is V.F's Balance Sheet?

The latest balance sheet data shows that V.F had liabilities of US$3.46b due within a year, and liabilities of US$6.50b falling due after that. Offsetting these obligations, it had cash of US$676.9m as well as receivables valued at US$1.30b due within 12 months. So its liabilities total US$7.97b more than the combination of its cash and short-term receivables.

When you consider that this deficiency exceeds the company's US$6.36b market capitalization, you might well be inclined to review the balance sheet intently. Hypothetically, extremely heavy dilution would be required if the company were forced to pay down its liabilities by raising capital at the current share price.

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).

With a net debt to EBITDA ratio of 5.6, it's fair to say V.F does have a significant amount of debt. However, its interest coverage of 2.8 is reasonably strong, which is a good sign. Even worse, V.F saw its EBIT tank 41% over the last 12 months. If earnings keep going like that over the long term, it has a snowball's chance in hell of paying off that debt. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine V.F'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, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So it's worth checking how much of that EBIT is backed by free cash flow. Over the last three years, V.F reported free cash flow worth 13% of its EBIT, which is really quite low. For us, cash conversion that low sparks a little paranoia about is ability to extinguish debt.

Our View

To be frank both V.F's net debt to EBITDA and its track record of (not) growing its EBIT make us rather uncomfortable with its debt levels. And furthermore, its interest cover also fails to instill confidence. Taking into account all the aforementioned factors, it looks like V.F has too much debt. While some investors love that sort of risky play, it's certainly not our cup of tea. 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. For example, we've discovered 2 warning signs for V.F (1 is significant!) that you should be aware of before investing here.

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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team@simplywallst.com