We think VF (NYSE: VFC) is taking risks with its debt

Legendary fund manager Li Lu (whom Charlie Munger supported) once said, “The biggest risk in investing is not price volatility, but the possibility that you will suffer a permanent loss of capital. So it can be obvious that you need to consider debt, when you think about how risky a given stock is because too much debt can sink a business. We notice that Company VF (NYSE: VFC) has debt on its balance sheet. But does this debt worry shareholders?

What risk does debt entail?

Debt is a tool to help businesses grow, but if a business is unable to repay its lenders, then it exists at their mercy. In the worst case scenario, a business can go bankrupt if it cannot pay its creditors. However, a more common (but still costly) event is when a company has to issue stock at bargain prices, constantly diluting shareholders, just to strengthen its balance sheet. That said, the most common situation is where a business manages its debt reasonably well – and to its own advantage. When we look at debt levels, we first consider both liquidity and debt levels.

See our latest analysis for VF

How many debts does VF carry?

The image below, which you can click for more details, shows that in April 2021, VF was in debt of US $ 5.70 billion, up from US $ 3.81 billion in a year. However, he also had $ 1.41 billion in cash, so his net debt is $ 4.29 billion.

Is VF’s balance sheet healthy?

The latest balance sheet data shows that VF had liabilities of US $ 2.21 billion due within one year and liabilities of US $ 8.49 billion due after that. In return, he had $ 1.41 billion in cash and $ 1.30 billion in receivables due within 12 months. As a result, its liabilities exceed the sum of its cash and (short-term) receivables by $ 7.98 billion.

While that might sound like a lot, it’s not that bad since VF has a massive market cap of US $ 30.4 billion, and therefore could likely strengthen its balance sheet by raising capital if needed. However, it is always worth taking a close look at your ability to repay your debt.

We use two main ratios to inform us about the levels of debt compared to earnings. The first is net debt divided by earnings before interest, taxes, depreciation, and amortization (EBITDA), while the second is the number of times its profit before interest and taxes (EBIT) covers its interest expense (or its coverage of interest, for short). Thus, we consider debt versus earnings with and without amortization charges.

VF’s debt is 4.4 times its EBITDA and its EBIT covers its interest expense 5.6 times. This suggests that while debt levels are significant, we would stop calling them problematic. It is important to note that VF’s EBIT has fallen 44% over the past twelve months. If this decline continues, then it will be more difficult to pay off the debt than to sell foie gras at a vegan convention. When analyzing debt levels, the balance sheet is the obvious starting point. But ultimately, the company’s future profitability will decide whether VF can strengthen its balance sheet over time. So if you are focused on the future you can check this out free report showing analysts’ earnings forecasts.

Finally, while the IRS may love accounting profits, lenders only accept hard cash. We therefore always check how much of this EBIT is converted into free cash flow. Over the past three years, VF has generated free cash flow of a very solid 92% of its EBIT, more than we expected. This puts him in a very strong position to pay off the debt.

Our point of view

VF’s rate of growth in EBIT and net debt to EBITDA certainly weighs on this, in our view. But his conversion from EBIT to free cash tells a very different story and suggests some resilience. We think VF’s debt makes it a bit risky, after considering the aforementioned data points together. This isn’t necessarily a bad thing, as leverage can increase returns on equity, but it’s something to be aware of. There is no doubt that we learn the most about debt from the balance sheet. However, not all investment risks lie on the balance sheet – far from it. For example – VF a 4 warning signs we think you should be aware.

At the end of the day, it’s often best to focus on businesses with no net debt. You can access our special list of these companies (all with a history of profit growth). It’s free.

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