Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a 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. We can see that Skechers U.S.A., Inc. (NYSE:SKX) does use debt in its business. But is this debt a concern to shareholders?
What Risk Does Debt Bring?
Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. 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, 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 Skechers U.S.A's Net Debt?
The image below, which you can click on for greater detail, shows that Skechers U.S.A had debt of US$301.4m at the end of December 2023, a reduction from US$339.3m over a year. But it also has US$1.26b in cash to offset that, meaning it has US$961.1m net cash.
How Healthy Is Skechers U.S.A's Balance Sheet?
According to the last reported balance sheet, Skechers U.S.A had liabilities of US$1.66b due within 12 months, and liabilities of US$1.49b due beyond 12 months. On the other hand, it had cash of US$1.26b and US$942.6m worth of receivables due within a year. So its liabilities total US$942.3m more than the combination of its cash and short-term receivables.
Given Skechers U.S.A has a market capitalization of US$8.77b, it's hard to believe these liabilities pose much threat. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time. Despite its noteworthy liabilities, Skechers U.S.A boasts net cash, so it's fair to say it does not have a heavy debt load!
In addition to that, we're happy to report that Skechers U.S.A has boosted its EBIT by 44%, 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 future earnings, more than anything, that will determine Skechers U.S.A'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, a company can only pay off debt with cold hard cash, not accounting profits. While Skechers U.S.A has net cash on its balance sheet, it's still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. Looking at the most recent three years, Skechers U.S.A recorded free cash flow of 36% of its EBIT, which is weaker than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.
Summing Up
While Skechers U.S.A does have more liabilities than liquid assets, it also has net cash of US$961.1m. And we liked the look of last year's 44% year-on-year EBIT growth. So we don't think Skechers U.S.A's use of debt is risky. 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. To that end, you should be aware of the 1 warning sign we've spotted with Skechers U.S.A .
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.