Howard Marks said it well when he said that, rather than worrying about stock price volatility, “the possibility of permanent loss is the risk I worry about…and that every practical investor that I know is worried”. It’s natural to consider a company’s balance sheet when looking at its riskiness, as debt is often involved when a company fails. Above all, G-III Clothing Group, Ltd. (NASDAQ:GIII) is in debt. But should shareholders worry about its use of debt?
When is debt a problem?
Generally speaking, debt only becomes a real problem when a company cannot easily repay it, either by raising capital or with its own cash flow. Ultimately, if the company cannot meet its legal debt repayment obligations, shareholders could walk away with nothing. Although not too common, we often see companies in debt permanently diluting their shareholders because lenders force them to raise capital at a ridiculous price. Of course, many companies use debt to finance their growth, without any negative consequences. The first step when considering a company’s debt levels is to consider its cash and debt together.
What is G-III Apparel Group’s debt?
The graph below, which you can click on for more details, shows that G-III Apparel Group had $517.5 million in debt as of October 2021; about the same as the previous year. On the other hand, it has $279.6 million in cash, resulting in a net debt of approximately $238.0 million.
A look at the responsibilities of G-III Apparel Group
According to the last published balance sheet, G-III Apparel Group had liabilities of US$547.0 million due within 12 months and liabilities of US$694.0 million due beyond 12 months. As compensation for these obligations, it had cash of US$279.6 million and receivables valued at US$844.4 million due within 12 months. Thus, its liabilities total $117.1 million more than the combination of its cash and short-term receivables.
Given that G-III Apparel Group has a market cap of $1.36 billion, it’s hard to believe that these liabilities pose a threat. However, we think it’s worth keeping an eye on the strength of its balance sheet, as it can change over time.
We measure a company’s leverage against its earning power by looking at its net debt divided by its earnings before interest, taxes, depreciation and amortization (EBITDA) and calculating how easily its earnings before interest and taxes (EBIT ) covers its interest charge (interest coverage). Thus, we consider debt to earnings with and without amortization and depreciation expense.
Looking at its net debt to EBITDA of 0.78 and its interest coverage of 5.6 times, it seems to us that G-III Apparel Group is probably using debt quite sensibly. But the interest payments are certainly enough to make us think about the affordability of its debt. Notably, G-III Apparel Group’s EBIT launched higher than Elon Musk, gaining a whopping 116% over last year. When analyzing debt levels, the balance sheet is the obvious starting point. But it is future earnings, more than anything, that will determine G-III Apparel Group’s ability to maintain a healthy balance sheet in the future. So if you want to see what the pros think, you might find this free analyst earnings forecast report Be interesting.
But our last consideration is also important, because a company cannot pay debt with paper profits; he needs cash. We therefore always check how much of this EBIT is converted into free cash flow. Over the past three years, G-III Apparel Group has generated free cash flow of a very strong 81% of its EBIT, more than expected. This puts him in a very strong position to pay off the debt.
Our point of view
G-III Apparel Group’s EBIT to free cash flow conversion suggests it can manage its debt as easily as Cristiano Ronaldo could score a goal against an under-14 goalkeeper. And this is only the beginning of good news since its EBIT growth rate is also very encouraging. Overall, we don’t think G-III Apparel Group is taking bad risks, as its leverage appears modest. The balance sheet therefore seems rather healthy to us. There is no doubt that we learn the most about debt from the balance sheet. But at the end of the day, every business can contain risks that exist outside of the balance sheet. For example – G-III Apparel Group has 1 warning sign we think you should know.
In the end, it’s often best to focus on companies that aren’t in debt. You can access our special list of these companies (all with a track record of earnings growth). It’s free.
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