Legendary fund manager Li Lu (whom Charlie Munger once backed) once said, “The biggest risk in investing is not price volatility, but whether you will suffer a permanent loss of capital. It’s natural to consider a company’s balance sheet when looking at its riskiness, as debt is often involved when a company fails. We can see that Hibett, Inc. (NASDAQ:HIBB) uses debt in its business. But the more important question is: what risk does this debt create?
Why is debt risky?
Debt is a tool to help businesses grow, but if a business is unable to repay its lenders, it exists at their mercy. Ultimately, if the company cannot meet its legal debt repayment obligations, shareholders could walk away with nothing. However, a more common (but still costly) event is when a company has to issue stock 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. The first thing to do when considering how much debt a business has is to look at its cash and debt together.
Check out our latest analysis for Hibbett
What is the Hibbett Debt?
You can click on the graph below for historical numbers, but it shows that in July 2022, Hibbett had debt of $88.5 million, an increase from zero, year over year. However, since he has a cash reserve of $28.5 million, his net debt is less, at around $60.1 million.
A look at Hibbett’s responsibilities
Zooming in on the latest balance sheet data, we can see that Hibbett had liabilities of US$332.4 million due within 12 months and liabilities of US$233.8 million due beyond. In compensation for these obligations, it had cash of US$28.5 million as well as receivables valued at US$16.5 million and maturing within 12 months. Thus, its liabilities total $521.2 million more than the combination of its cash and short-term receivables.
This shortfall is sizable relative to its market capitalization of US$827.8 million, so he suggests shareholders watch Hibbett’s use of debt. This suggests shareholders would be heavily diluted if the company needed to shore up its balance sheet quickly.
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). The advantage of this approach is that we consider both the absolute amount of debt (with net debt to EBITDA) and the actual interest expense associated with that debt (with its interest coverage ratio ).
Hibbett’s net debt is only 0.35 times its EBITDA. And its EBIT covers its interest charges 223 times. So we’re pretty relaxed about his super-conservative use of debt. Luckily Hibbett’s load isn’t too heavy, as its EBIT is down 49% year-on-year. When it comes to paying off debt, lower income is no more helpful than sugary sodas for your health. There is no doubt that we learn the most about debt from the balance sheet. But it is future earnings, more than anything, that will determine Hibbett’s ability to maintain a healthy balance sheet in the future. So if you want to see what the professionals think, you might find this free analyst earnings forecast report 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, Hibbett has recorded free cash flow of 45% of its EBIT, which is lower than expected. It’s not great when it comes to paying off debt.
Our point of view
We feel some apprehension about Hibbett’s challenging EBIT growth rate, but we also have some positives to focus on. For example, its interest coverage and its net debt to EBITDA give us some confidence in its ability to manage its debt. When we consider all the factors discussed, it seems to us that Hibbett is taking risks with his use of debt. While this debt may increase returns, we believe the company now has sufficient leverage. 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 outside of the balance sheet. For example, we found 3 warning signs for Hibbett (1 is concerning!) that you should be aware of before investing here.
Of course, if you’re the type of investor who prefers to buy stocks without the burden of debt, then feel free to check out our exclusive list of cash-efficient growth stocks today.
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This Simply Wall St article is general in nature. We provide commentary based on historical data and analyst forecasts only using unbiased methodology and our articles are not intended to be financial advice. It is not a recommendation to buy or sell stocks and does not take into account your objectives or financial situation. Our goal is to bring you targeted long-term analysis based on fundamental data. Note that our analysis may not take into account the latest announcements from price-sensitive companies or qualitative materials. Simply Wall St has no position in the stocks mentioned.
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