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Premier Investments (ASX:PMV) Has A Rock Solid Balance Sheet

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David Iben put it well when he said, ‘Volatility is not a risk we care about. What we care about is avoiding the permanent loss of capital.’ 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. We can see that Premier Investments Limited (ASX:PMV) does use debt in its business. But the more important question is: how much risk is that debt creating?

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. Ultimately, if the company can’t fulfill its legal obligations to repay debt, shareholders could walk away with nothing. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. Having said that, the most common situation is where a company manages its debt reasonably well – and to its own advantage. When we examine debt levels, we first consider both cash and debt levels, together.

See our latest analysis for Premier Investments

What Is Premier Investments’s Net Debt?

The image below, which you can click on for greater detail, shows that Premier Investments had debt of AU$69.0m at the end of January 2022, a reduction from AU$146.7m over a year. But on the other hand it also has AU$478.9m in cash, leading to a AU$409.9m net cash position.

debt-equity-history-analysis

How Strong Is Premier Investments’ Balance Sheet?

The latest balance sheet data shows that Premier Investments had liabilities of AU$426.1m due within a year, and liabilities of AU$225.9m falling due after that. Offsetting these obligations, it had cash of AU$478.9m as well as receivables valued at AU$14.3m due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by AU$158.9m.

Of course, Premier Investments has a market capitalization of AU$3.80b, so these liabilities are probably manageable. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time. While it does have liabilities worth noting, Premier Investments also has more cash than debt, so we’re pretty confident it can manage its debt safely.

Fortunately, Premier Investments grew its EBIT by 4.8% in the last year, making that debt load look even more manageable. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately the future profitability of the business will decide if Premier Investments 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.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. Premier Investments may have net cash on the balance sheet, but it is still interesting to look at how well the business converts its earnings before interest and tax (EBIT) to free cash flow, because that will influence both its need for, and its capacity to manage debt. Over the last three years, Premier Investments actually produced more free cash flow than EBIT. That sort of strong cash conversion gets us as excited as the crowd when the beat drops at a Daft Punk concert.

Summing up

While it is always sensible to look at a company’s total liabilities, it is very reassuring that Premier Investments has AU$409.9m in net cash. The cherry on top was that in converted 127% of that EBIT to free cash flow, bringing in AU$317m. So is Premier Investments’s debt a risk? It doesn’t seem so to us. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet – far from it. For example, we’ve discovered 1 warning sign for Premier Investments 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.

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

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.