We Think Leon's Furniture (TSE:LNF) Can Manage Its Debt With Ease

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.' 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 Leon's Furniture Limited (TSE:LNF) does use debt in its business. But the real question is whether this debt is making the company risky.

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 common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. Of course, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. When we examine debt levels, we first consider both cash and debt levels, together.

See our latest analysis for Leon's Furniture

What Is Leon's Furniture's Net Debt?

As you can see below, Leon's Furniture had CA$90.0m of debt, at June 2021, which is about the same as the year before. You can click the chart for greater detail. However, its balance sheet shows it holds CA$381.2m in cash, so it actually has CA$291.2m net cash.

How Healthy Is Leon's Furniture's Balance Sheet?

The latest balance sheet data shows that Leon's Furniture had liabilities of CA$819.3m due within a year, and liabilities of CA$475.1m falling due after that. Offsetting these obligations, it had cash of CA$381.2m as well as receivables valued at CA$126.8m due within 12 months. So its liabilities total CA$786.4m more than the combination of its cash and short-term receivables.

While this might seem like a lot, it is not so bad since Leon's Furniture has a market capitalization of CA$1.78b, and so it could probably strengthen its balance sheet by raising capital if it needed to. But it's clear that we should definitely closely examine whether it can manage its debt without dilution. Despite its noteworthy liabilities, Leon's Furniture 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 Leon's Furniture has boosted its EBIT by 39%, thus reducing the spectre of future debt repayments. There's no doubt that we learn most about debt from the balance sheet. But it is future earnings, more than anything, that will determine Leon's Furniture's ability to maintain a healthy balance sheet going forward. 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. Leon's Furniture 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. Happily for any shareholders, Leon's Furniture actually produced more free cash flow than EBIT over the last three years. There's nothing better than incoming cash when it comes to staying in your lenders' good graces.

Summing up

While Leon's Furniture does have more liabilities than liquid assets, it also has net cash of CA$291.2m. And it impressed us with free cash flow of CA$270m, being 125% of its EBIT. So we don't think Leon's Furniture's use of debt is risky. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. These risks can be hard to spot. Every company has them, and we've spotted 2 warning signs for Leon's Furniture you should know about.

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

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.

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