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.’ 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 The TJX Companies, Inc. (NYSE:TJX) does use debt in its business. 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. Part and parcel of capitalism is the process of ‘creative destruction’ where failed businesses are mercilessly liquidated by their bankers. 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. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. The first step when considering a company’s debt levels is to consider its cash and debt together.

How Much Debt Does TJX Companies Carry?

As you can see below, TJX Companies had US$3.35b of debt at July 2021, down from US$6.19b a year prior. But on the other hand it also has US$7.11b in cash, leading to a US$3.75b net cash position.

A Look At TJX Companies’ Liabilities

According to the last reported balance sheet, TJX Companies had liabilities of US$10.0b due within 12 months, and liabilities of US$12.3b due beyond 12 months. Offsetting this, it had US$7.11b in cash and US$737.3m in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by US$14.5b.

Of course, TJX Companies has a titanic market capitalization of US$85.5b, so these liabilities are probably manageable. But there are sufficient liabilities that we would certainly recommend shareholders continue to monitor the balance sheet, going forward. Despite its noteworthy liabilities, TJX Companies boasts net cash, so it’s fair to say it does not have a heavy debt load!

Even more impressive was the fact that TJX Companies grew its EBIT by 216% over twelve months. If maintained that growth will make the debt even more manageable in the years ahead. 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 TJX Companies’s ability to maintain a healthy balance sheet going forward.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. While TJX Companies 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. Over the last three years, TJX Companies 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

Although TJX Companies’s balance sheet isn’t particularly strong, due to the total liabilities, it is clearly positive to see that it has net cash of US$3.75b. And it impressed us with free cash flow of US$4.6b, being 105% of its EBIT. So we don’t think TJX Companies’s use of debt is risky. The balance sheet is clearly the area to focus on when you are analysing debt.