Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk.' 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 note that Signet Jewelers Limited (NYSE:SIG) does have debt on its balance sheet. But the more important question is: how much risk is that debt creating?

Why Does Debt Bring Risk?

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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 think about a company's use of debt, we first look at cash and debt together.

What Is Signet Jewelers's Debt?

As you can see below, Signet Jewelers had US$147.8m of debt, at May 2024, which is about the same as the year before. You can click the chart for greater detail. However, it does have US$729.3m in cash offsetting this, leading to net cash of US$581.5m.

How Healthy Is Signet Jewelers' Balance Sheet?

We can see from the most recent balance sheet that Signet Jewelers had liabilities of US$1.75b falling due within a year, and liabilities of US$1.99b due beyond that. Offsetting this, it had US$729.3m in cash and US$9.30m in receivables that were due within 12 months. So it has liabilities totalling US$3.00b more than its cash and near-term receivables, combined.

This is a mountain of leverage relative to its market capitalization of US$3.96b. This suggests shareholders would be heavily diluted if the company needed to shore up its balance sheet in a hurry. While it does have liabilities worth noting, Signet Jewelers also has more cash than debt, so we're pretty confident it can manage its debt safely.

The modesty of its debt load may become crucial for Signet Jewelers if management cannot prevent a repeat of the 37% cut to EBIT over the last year. When a company sees its earnings tank, it can sometimes find its relationships with its lenders turn sour. 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 Signet Jewelers'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. Signet Jewelers 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. Over the last three years, Signet Jewelers recorded free cash flow worth a fulsome 82% of its EBIT, which is stronger than we'd usually expect. That puts it in a very strong position to pay down debt.

Summing Up

While Signet Jewelers does have more liabilities than liquid assets, it also has net cash of US$581.5m. And it impressed us with free cash flow of US$649m, being 82% of its EBIT. So we are not troubled with Signet Jewelers's debt use. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. For example, we've discovered 2 warning signs for Signet Jewelers (1 is concerning!) that you should be aware of before investing here.

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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.
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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team@simplywallst.com