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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 note that Nordstrom, Inc. (NYSE:JWN) does have debt on its balance sheet. But the real question is whether this debt is making the company risky.
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 common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. Of course, plenty of companies use debt to fund growth, without any negative consequences. The first step when considering a company's debt levels is to consider its cash and debt together.
Check out our latest analysis for Nordstrom
What Is Nordstrom's Net Debt?
As you can see below, Nordstrom had US$2.68b of debt, at August 2019, which is about the same the year before. You can click the chart for greater detail. On the flip side, it has US$956.0m in cash leading to net debt of about US$1.72b.
How Strong Is Nordstrom's Balance Sheet?
We can see from the most recent balance sheet that Nordstrom had liabilities of US$4.43b falling due within a year, and liabilities of US$4.75b due beyond that. Offsetting these obligations, it had cash of US$956.0m as well as receivables valued at US$211.0m due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by US$8.01b.
The deficiency here weighs heavily on the US$5.10b company itself, as if a child were struggling under the weight of an enormous back-pack full of books, his sports gear, and a trumpet." So we'd watch its balance sheet closely, without a doubt After all, Nordstrom would likely require a major re-capitalisation if it had to pay its creditors today.
We use two main ratios to inform us about debt levels relative to earnings. The first is net debt divided by earnings before interest, tax, depreciation, and amortization (EBITDA), while the second is how many times its earnings before interest and tax (EBIT) covers its interest expense (or its interest cover, for short). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.