Here's Why G-III Apparel Group (NASDAQ:GIII) Has A Meaningful Debt Burden

Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' So it seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. As with many other companies G-III Apparel Group, Ltd. (NASDAQ:GIII) makes use of debt. But the more important question is: how much risk is that debt creating?

When Is Debt A Problem?

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. If things get really bad, the lenders can take control of the business. 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. The first step when considering a company's debt levels is to consider its cash and debt together.

Our analysis indicates that GIII is potentially undervalued!

What Is G-III Apparel Group's Net Debt?

The image below, which you can click on for greater detail, shows that at July 2022 G-III Apparel Group had debt of US$575.8m, up from US$517.5m in one year. However, it also had US$151.0m in cash, and so its net debt is US$424.8m.

A Look At G-III Apparel Group's Liabilities

Zooming in on the latest balance sheet data, we can see that G-III Apparel Group had liabilities of US$769.4m due within 12 months and liabilities of US$728.8m due beyond that. Offsetting this, it had US$151.0m in cash and US$488.5m in receivables that were due within 12 months. So it has liabilities totalling US$858.6m more than its cash and near-term receivables, combined.

This deficit casts a shadow over the US$568.4m company, like a colossus towering over mere mortals. So we definitely think shareholders need to watch this one closely. After all, G-III Apparel Group would likely require a major re-capitalisation if it had to pay its creditors today.

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). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

We'd say that G-III Apparel Group's moderate net debt to EBITDA ratio ( being 1.5), indicates prudence when it comes to debt. And its commanding EBIT of 65.0 times its interest expense, implies the debt load is as light as a peacock feather. On the other hand, G-III Apparel Group saw its EBIT drop by 8.1% in the last twelve months. If earnings continue to decline at that rate the company may have increasing difficulty managing its debt load. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine G-III Apparel Group's ability to maintain a healthy balance sheet going forward. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So it's worth checking how much of that EBIT is backed by free cash flow. In the last three years, G-III Apparel Group's free cash flow amounted to 44% of its EBIT, less than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.

Our View

We'd go so far as to say G-III Apparel Group's level of total liabilities was disappointing. But at least it's pretty decent at covering its interest expense with its EBIT; that's encouraging. Looking at the bigger picture, it seems clear to us that G-III Apparel Group's use of debt is creating risks for the company. If all goes well, that should boost returns, but on the flip side, the risk of permanent capital loss is elevated by the debt. In light of our reservations about the company's balance sheet, it seems sensible to check if insiders have been selling shares recently.

When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.

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This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.