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. So it seems the smart money knows that debt – which is usually involved in bankruptcies – is a very important factor, when you assess how risky a company is. Importantly, Deckers Outdoor Corporation (NYSE:DECK) does carry debt. But the more important question is: how much risk is that debt creating?
When Is Debt A Problem?
Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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. Of course, plenty of companies use debt to fund growth, without any negative consequences. The first step when considering a company’s debt levels is to consider its cash and debt together.
How Much Debt Does Deckers Outdoor Carry?
You can click the graphic below for the historical numbers, but it shows that Deckers Outdoor had US$44.2m of debt in September 2019, down from US$102.7m, one year before. However, it does have US$177.7m in cash offsetting this, leading to net cash of US$133.5m.
A Look At Deckers Outdoor’s Liabilities
Zooming in on the latest balance sheet data, we can see that Deckers Outdoor had liabilities of US$465.8m due within 12 months and liabilities of US$309.5m due beyond that. Offsetting these obligations, it had cash of US$177.7m as well as receivables valued at US$348.1m due within 12 months. So its liabilities total US$249.6m more than the combination of its cash and short-term receivables.
Of course, Deckers Outdoor has a market capitalization of US$4.90b, 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. Despite its noteworthy liabilities, Deckers Outdoor 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 Deckers Outdoor has boosted its EBIT by 32%, thus reducing the spectre of future debt repayments. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Deckers Outdoor can strengthen its balance sheet over time.
Finally, a company can only pay off debt with cold hard cash, not accounting profits. While Deckers Outdoor 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. Happily for any shareholders, Deckers Outdoor actually produced more free cash flow than EBIT over the last three years. That sort of strong cash generation warms our hearts like a puppy in a bumblebee suit.
Summing up
We could understand if investors are concerned about Deckers Outdoor’s liabilities, but we can be reassured by the fact it has has net cash of US$133.5m. The cherry on top was that in converted 109% of that EBIT to free cash flow, bringing in US$274m. So we don’t think Deckers Outdoor’s use of debt is risky. We’d be very excited to see if Deckers Outdoor insiders have been snapping up shares.
