We believe Target (NYSE: TGT) can manage its debt with ease

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. Like many other companies Target company (NYSE: TGT) uses debt. But the real question is whether this debt makes the business risky.

When is debt a problem?

Debt helps a business until the business struggles to repay it, either with new capital or with free cash flow. An integral part of capitalism is the process of “creative destruction” where bankrupt companies are ruthlessly liquidated by their bankers. However, a more common (but still painful) scenario is that he has to raise new equity at low cost, thereby constantly diluting shareholders. By replacing dilution, however, debt can be a very good tool for companies that need capital to invest in growth at high rates of return. The first step in examining a company’s debt levels is to consider its cash flow and debt together.

Check out our latest analysis for Target

What is Target’s debt?

The chart below, which you can click for more details, shows that Target had $ 12.8 billion in debt as of October 2021; about the same as the year before. However, it has $ 5.77 billion in cash offsetting that, leading to net debt of around $ 7.00 billion.

NYSE: Historical TGT Debt to Equity November 29, 2021

A look at the target’s liabilities

According to the latest published balance sheet, Target had liabilities of US $ 23.4 billion due within 12 months and liabilities of US $ 17.3 billion due beyond 12 months. On the other hand, he had $ 5.77 billion in cash and $ 1.14 billion in receivables within a year. As a result, its liabilities exceed the sum of its cash and (short-term) receivables by $ 33.7 billion.

While that might sound like a lot, it’s not that big of a deal since Target has a massive market cap of US $ 118.1 billion, so it could likely strengthen its balance sheet by raising capital if needed. But we absolutely want to keep our eyes open for indications that its debt is too risky.

In order to measure a company’s debt relative to its profits, we calculate its net debt divided by its earnings before interest, taxes, depreciation and amortization (EBITDA) and its profit before interest and taxes (EBIT) divided by its interest. debtors (its interest coverage). In this way, we consider both the absolute amount of debt, as well as the interest rates paid on it.

Target has a low net debt to EBITDA ratio of just 0.63. And its EBIT easily covers its interest costs, being 20.3 times higher. So we’re pretty relaxed about its ultra-conservative use of debt. On top of that, Target has increased its EBIT by 39% over the past twelve months, and that growth will make it easier to process its debt. There is no doubt that we learn the most about debt from the balance sheet. But it’s future earnings, more than anything, that will determine Target’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 analyst earnings forecast report interesting.

Finally, a business can only pay off its debts with hard cash, not with book profits. It is therefore worth checking to what extent this EBIT is supported by free cash flow. Over the past three years, Target has recorded free cash flow totaling 86% of its EBIT, which is higher than what we usually expected. This positions it well to repay debt if it is desirable.

Our point of view

Fortunately, Target’s impressive interest coverage means it has the upper hand over its debt. And the good news does not end there, since its conversion of EBIT into free cash flow also confirms this impression! Given this array of factors, it seems to us that Target is fairly conservative with its debt, and the risks appear to be well managed. We are therefore not worried about the use of a small leverage on the balance sheet. The balance sheet is clearly the area to focus on when analyzing debt. But at the end of the day, every business can contain risks that exist off the balance sheet. We have identified 1 warning sign with Target and understanding them should be part of your investment process.

If you want to invest in companies that can generate profits without the burden of debt, check out this free list of growing companies that have net cash on the balance sheet.

This Simply Wall St article is general in nature. We provide commentary based on historical data and analyst forecasts using only unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell shares and does not take into account your goals or your financial situation. Our aim is to bring you long-term, targeted analysis based on fundamental data. Note that our analysis may not take into account the latest announcements from price sensitive companies or qualitative documents. Simply Wall St has no position in the mentioned stocks.

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