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. We note that Samsonite International S.A. (HKG:1910) does have debt on its balance sheet. But the real question is whether this debt is making the company risky.
When Is Debt Dangerous?
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. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. Of course, plenty of companies use debt to fund growth, without any negative consequences. When we examine debt levels, we first consider both cash and debt levels, together.
What Is Samsonite International's Net Debt?
As you can see below, Samsonite International had US$1.81b of debt at June 2024, down from US$1.92b a year prior. However, it does have US$815.5m in cash offsetting this, leading to net debt of about US$998.5m.
How Strong Is Samsonite International's Balance Sheet?
Zooming in on the latest balance sheet data, we can see that Samsonite International had liabilities of US$1.18b due within 12 months and liabilities of US$2.45b due beyond that. On the other hand, it had cash of US$815.5m and US$346.1m worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by US$2.47b.
This deficit is considerable relative to its market capitalization of US$3.36b, so it does suggest shareholders should keep an eye on Samsonite International's use of debt. Should its lenders demand that it shore up the balance sheet, shareholders would likely face severe dilution.
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). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.
Looking at its net debt to EBITDA of 1.4 and interest cover of 5.8 times, it seems to us that Samsonite International is probably using debt in a pretty reasonable way. But the interest payments are certainly sufficient to have us thinking about how affordable its debt is. If Samsonite International can keep growing EBIT at last year's rate of 18% over the last year, then it will find its debt load easier to manage. There's no doubt that we learn most about debt from the balance sheet. But ultimately the future profitability of the business will decide if Samsonite International can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.
But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. Over the most recent three years, Samsonite International recorded free cash flow worth 74% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This free cash flow puts the company in a good position to pay down debt, when appropriate.
Our View
When it comes to the balance sheet, the standout positive for Samsonite International was the fact that it seems able to convert EBIT to free cash flow confidently. However, our other observations weren't so heartening. For example, its level of total liabilities makes us a little nervous about its debt. Considering this range of data points, we think Samsonite International is in a good position to manage its debt levels. Having said that, the load is sufficiently heavy that we would recommend any shareholders keep a close eye on it. 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. Be aware that Samsonite International is showing 2 warning signs in our investment analysis , you should know about...
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.