Flexsteel Industries (NASDAQ:FLXS) Use Of Debt Could Be Considered Risky

Published
July 05, 2022
NasdaqGS:FLXS
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Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. We note that Flexsteel Industries, Inc. (NASDAQ:FLXS) does have debt on its balance sheet. But the real question is whether this debt is making the company risky.

Why Does Debt Bring Risk?

Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we examine debt levels, we first consider both cash and debt levels, together.

Check out our latest analysis for Flexsteel Industries

How Much Debt Does Flexsteel Industries Carry?

You can click the graphic below for the historical numbers, but it shows that as of March 2022 Flexsteel Industries had US$41.6m of debt, an increase on none, over one year. However, it does have US$3.40m in cash offsetting this, leading to net debt of about US$38.2m.

debt-equity-history-analysis
NasdaqGS:FLXS Debt to Equity History July 5th 2022

How Strong Is Flexsteel Industries' Balance Sheet?

We can see from the most recent balance sheet that Flexsteel Industries had liabilities of US$71.1m falling due within a year, and liabilities of US$78.1m due beyond that. Offsetting these obligations, it had cash of US$3.40m as well as receivables valued at US$44.5m due within 12 months. So its liabilities total US$101.4m more than the combination of its cash and short-term receivables.

When you consider that this deficiency exceeds the company's US$100.0m market capitalization, you might well be inclined to review the balance sheet intently. In the scenario where the company had to clean up its balance sheet quickly, it seems likely shareholders would suffer extensive dilution.

We measure a company's debt load relative to its earnings power by looking at its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and by calculating how easily its earnings before interest and tax (EBIT) cover its interest expense (interest cover). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

We'd say that Flexsteel Industries's moderate net debt to EBITDA ratio ( being 2.5), indicates prudence when it comes to debt. And its commanding EBIT of 16.7 times its interest expense, implies the debt load is as light as a peacock feather. Importantly, Flexsteel Industries's EBIT fell a jaw-dropping 36% in the last twelve months. If that earnings trend continues then paying off its debt will be about as easy as herding cats on to a roller coaster. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Flexsteel Industries can strengthen its balance sheet over time. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. Over the last two years, Flexsteel Industries saw substantial negative free cash flow, in total. While investors are no doubt expecting a reversal of that situation in due course, it clearly does mean its use of debt is more risky.

Our View

On the face of it, Flexsteel Industries's conversion of EBIT to free cash flow left us tentative about the stock, and its EBIT growth rate was no more enticing than the one empty restaurant on the busiest night of the year. But at least it's pretty decent at covering its interest expense with its EBIT; that's encouraging. We're quite clear that we consider Flexsteel Industries to be really rather risky, as a result of its balance sheet health. For this reason we're pretty cautious about the stock, and we think shareholders should keep a close eye on its liquidity. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. Case in point: We've spotted 3 warning signs for Flexsteel Industries you should be aware of, and 1 of them is significant.

If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.

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