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.' 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. As with many other companies G-III Apparel Group, Ltd. (NASDAQ:GIII) makes use of debt. But should shareholders be worried about its use of debt?

When Is Debt A Problem?

Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. When we examine debt levels, we first consider both cash and debt levels, together.

Check out our latest analysis for G-III Apparel Group

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

The image below, which you can click on for greater detail, shows that G-III Apparel Group had debt of US$466.0m at the end of July 2023, a reduction from US$575.8m over a year. However, it also had US$197.7m in cash, and so its net debt is US$268.3m.

How Healthy Is G-III Apparel Group's Balance Sheet?

The latest balance sheet data shows that G-III Apparel Group had liabilities of US$624.0m due within a year, and liabilities of US$657.1m falling due after that. Offsetting these obligations, it had cash of US$197.7m as well as receivables valued at US$519.4m due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by US$564.0m.

While this might seem like a lot, it is not so bad since G-III Apparel Group has a market capitalization of US$1.16b, and so it could probably strengthen its balance sheet by raising capital if it needed to. But it's clear that we should definitely closely examine whether it can manage its debt without dilution.

In order to size up a company's debt relative to its earnings, we calculate its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and its earnings before interest and tax (EBIT) divided by its interest expense (its interest cover). The advantage of this approach is that we take into account both the absolute quantum of debt (with net debt to EBITDA) and the actual interest expenses associated with that debt (with its interest cover ratio).

While G-III Apparel Group's low debt to EBITDA ratio of 1.2 suggests only modest use of debt, the fact that EBIT only covered the interest expense by 3.8 times last year does give us pause. But the interest payments are certainly sufficient to have us thinking about how affordable its debt is. Shareholders should be aware that G-III Apparel Group's EBIT was down 36% last year. If that decline continues then paying off debt will be harder than selling foie gras at a vegan convention. The balance sheet is clearly the area to focus on when you are analysing debt. 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're focused on the future you can check out this free report showing analyst profit forecasts.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. So we always check how much of that EBIT is translated into free cash flow. Looking at the most recent three years, G-III Apparel Group recorded free cash flow of 32% of its EBIT, which is weaker than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.

Our View

Mulling over G-III Apparel Group's attempt at (not) growing its EBIT, we're certainly not enthusiastic. But on the bright side, its net debt to EBITDA is a good sign, and makes us more optimistic. Once we consider all the factors above, together, it seems to us that G-III Apparel Group's debt is making it a bit risky. Some people like that sort of risk, but we're mindful of the potential pitfalls, so we'd probably prefer it carry less debt. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. For example - G-III Apparel Group has 1 warning sign we think you should be aware of.

At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.

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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.