Warren Buffett famously said, 'Volatility is far from synonymous with risk.' 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 Tapestry, Inc. (NYSE:TPR) does use debt in its business. But is this debt a concern to shareholders?
When Is Debt Dangerous?
Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. 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. 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.
What Is Tapestry's Net Debt?
You can click the graphic below for the historical numbers, but it shows that as of March 2024 Tapestry had US$7.70b of debt, an increase on US$1.67b, over one year. However, because it has a cash reserve of US$7.42b, its net debt is less, at about US$280.7m.
How Strong Is Tapestry's Balance Sheet?
The latest balance sheet data shows that Tapestry had liabilities of US$1.37b due within a year, and liabilities of US$9.59b falling due after that. Offsetting this, it had US$7.42b in cash and US$499.2m in receivables that were due within 12 months. So it has liabilities totalling US$3.04b more than its cash and near-term receivables, combined.
This deficit isn't so bad because Tapestry is worth US$9.83b, and thus could probably raise enough capital to shore up its balance sheet, if the need arose. However, it is still worthwhile taking a close look at its ability to pay off debt.
We measure a company's debt load relative to its earnings power by looking at its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and by calculating how easily its earnings before interest and tax (EBIT) cover its interest expense (interest cover). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.
Tapestry's net debt is only 0.20 times its EBITDA. And its EBIT covers its interest expense a whopping 74.2 times over. So you could argue it is no more threatened by its debt than an elephant is by a mouse. Fortunately, Tapestry grew its EBIT by 9.0% in the last year, making that debt load look even more manageable. 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 Tapestry's ability to maintain a healthy balance sheet going forward. So if you're focused on the future you can check out this free report showing analyst profit forecasts.
Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. So the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. Over the most recent three years, Tapestry recorded free cash flow worth 78% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This free cash flow puts the company in a good position to pay down debt, when appropriate.
Our View
Happily, Tapestry's impressive interest cover implies it has the upper hand on its debt. And the good news does not stop there, as its conversion of EBIT to free cash flow also supports that impression! Zooming out, Tapestry seems to use debt quite reasonably; and that gets the nod from us. After all, sensible leverage can boost returns on equity. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. For instance, we've identified 1 warning sign for Tapestry that you should be aware of.
Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.
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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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