Berkshire Hathaway’s Charlie Munger-backed outside fund manager Li Lu is quick to say, “The biggest risk in investing isn’t price volatility, but whether you’re going to suffer a permanent loss of capital “. So it may be obvious that you need to take debt into account when thinking about the risk of a given stock, because too much debt can sink a business. We notice that Duluth Holdings Inc. (NASDAQ:DLTH) has debt on its balance sheet. But should shareholders worry about its use of debt?
When is debt dangerous?
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. If things go really bad, lenders can take over the business. However, a more frequent (but still costly) event is when a company has to issue shares at bargain prices, permanently diluting shareholders, just to shore up its balance sheet. By replacing dilution, however, debt can be a great tool for companies that need capital to invest in growth 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 Duluth Holdings’ net debt?
As you can see below, Duluth Holdings had $27.4 million in debt as of October 2021, up from $119.9 million the previous year. However, he has $20.4 million in cash to offset this, resulting in a net debt of approximately $7.06 million.
A look at the liabilities of Duluth Holdings
The latest balance sheet data shows that Duluth Holdings had liabilities of $116.7 million due within the year, and liabilities of $186.2 million due thereafter. In compensation for these obligations, it had cash of 20.4 million US dollars as well as receivables valued at 7.73 million US dollars and maturing within 12 months. Thus, its liabilities total $274.8 million more than the combination of its cash and short-term receivables.
While that might sound like a lot, it’s not too bad since Duluth Holdings has a market capitalization of $473.8 million, so it could probably bolster its balance sheet by raising capital if needed. But we definitely want to keep our eyes peeled for indications that its debt is too risky. Either way, Duluth Holdings has virtually no net debt, so it’s fair to say it’s not heavily leveraged!
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). In this way, we consider both the absolute amount of debt, as well as the interest rates paid on it.
Duluth Holdings has very little debt (net of cash) and has a debt to EBITDA ratio of 0.094 and an EBIT of 10.3 times interest expense. Indeed, relative to its earnings, its leverage seems light as a feather. On top of that, Duluth Holdings has grown its EBIT by 88% over the past twelve months, and this growth will make it easier to manage its debt. When analyzing debt levels, the balance sheet is the obvious starting point. But ultimately, the company’s future profitability will decide whether Duluth Holdings can strengthen its balance sheet over time. So if you want to see what the pros think, you might find this free analyst earnings forecast report Be interesting.
Finally, a company can only repay its debts with cash, not book profits. So the logical step is to look at what proportion of that EBIT is actual free cash flow. Over the past three years, Duluth Holdings has recorded free cash flow of 85% of its EBIT, which is higher than we would normally expect. This puts him in a very strong position to pay off the debt.
Our point of view
The good news is that Duluth Holdings’ demonstrated ability to convert EBIT to free cash flow delights us like a fluffy puppy does a toddler. But, on a darker note, we’re a bit concerned about his total passive level. Overall, we think Duluth Holdings’ use of debt seems entirely reasonable and we’re not worried about that. After all, reasonable leverage can increase return on equity. Of course, we wouldn’t say no to the extra confidence we’d gain if we knew Duluth Holdings insiders bought stock: if you’re on the same page, you can find out if insiders are buying by clicking on this link.
In the end, sometimes it’s easier to focus on companies that don’t even need to take on debt. Readers can access a list of growth stocks without net debt 100% freeat present.
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