Warren Buffett said: “Volatility is far from synonymous with risk. So it seems smart money knows that debt – which is usually involved in bankruptcies – is a very important factor when you’re assessing a company’s risk. We note that Climbing, Incorporated (NASDAQ:ESCA) has debt on its balance sheet. But should shareholders worry about its use of debt?
When is debt dangerous?
Debt is a tool to help businesses grow, but if a business is unable to repay its lenders, it exists at their mercy. If things go really bad, lenders can take over the business. However, a more common (but still painful) scenario is that it has to raise new equity at a low price, thereby permanently diluting shareholders. That said, the most common situation is when a company manages its debt reasonably well – and to its own benefit. The first step when considering a company’s debt levels is to consider its cash and debt together.
What is Escalade’s net debt?
You can click on the graph below for historical numbers, but it shows that in March 2022, Escalade had $100.0 million in debt, an increase of $46.9 million, year-over-year. On the other hand, he has $6.39 million in cash, resulting in a net debt of around $93.6 million.
A Look at Escalade’s Responsibilities
Zooming in on the latest balance sheet data, we can see that Escalade had liabilities of US$56.1 million due within 12 months and liabilities of US$99.4 million due beyond. In compensation for these obligations, it had cash of US$6.39 million as well as receivables valued at US$67.3 million and maturing within 12 months. Thus, its liabilities total $81.7 million more than the combination of its cash and short-term receivables.
Escalade has a market capitalization of $171.3 million, so it could very likely raise funds to improve its balance sheet, should the need arise. But it is clear that it is essential to examine closely whether it can manage its debt without dilution.
In order to assess a company’s debt relative to its earnings, we calculate its net debt divided by its earnings before interest, taxes, depreciation and amortization (EBITDA) and its earnings before interest and taxes (EBIT) divided by its expenses. interest (its 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 ).
We would say that Escalade’s moderate net debt to EBITDA ratio (2.4) indicates caution in leverage. And its towering EBIT of 18.4 times its interest expense means that the debt burden is as light as a peacock feather. Unfortunately, Escalade’s EBIT has dropped 10% over the past four quarters. If that kind of decline isn’t stopped, then managing his debt will be harder than selling broccoli-flavored ice cream for a premium. 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 Escalade’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.
Finally, a business needs free cash flow to pay off its debts; book profits are not enough. It is therefore worth checking how much of this EBIT is supported by free cash flow. Over the past three years, Escalade has actually had a cash outflow, overall. Debt is generally more expensive and almost always riskier in the hands of a company with negative free cash flow. Shareholders should hope for an improvement.
Our point of view
At first glance, Escalade’s EBIT growth rate left us wondering about the stock, and its conversion of EBIT to free cash flow was no more appealing than the single empty restaurant on the busiest night. of the year. But on the bright side, its interest coverage is a good sign and makes us more optimistic. Looking at the balance sheet and taking all of these factors into account, we believe debt makes Escalation a bit risky. Some people like that kind of risk, but we’re aware of the potential pitfalls, so we’d probably prefer it to take on less debt. When analyzing debt levels, the balance sheet is the obvious starting point. But at the end of the day, every business can contain risks that exist outside of the balance sheet. To do this, you need to find out about the 2 warning signs we spotted with Escalade (including 1 that is concerning) .
If you are interested in investing in companies that can generate profits without the burden of debt, then check out this free list of growing companies that have net cash on the balance sheet.
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