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The external fund manager backed by Berkshire Hathaway’s Charlie Munger, Li Lu, makes no bones about it when he says ‘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. We note that G-III Apparel Group, Ltd. (NASDAQ:GIII) does have debt on its balance sheet. But the real question is whether this debt is making the company risky.
What Risk Does Debt Bring?
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. If things get really bad, the lenders can take control of the business. 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. Of course, plenty of companies use debt to fund growth, without any negative consequences. The first step when considering a company’s debt levels is to consider its cash and debt together.
How Much Debt Does G-III Apparel Group Carry?
You can click the graphic below for the historical numbers, but it shows that G-III Apparel Group had US$411.1m of debt in April 2019, down from US$448.3m, one year before However, because it has a cash reserve of US$48.3m, its net debt is less, at about US$362.8m.
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$540.2m due within a year, and liabilities of US$719.5m falling due after that. Offsetting this, it had US$48.3m in cash and US$478.4m in receivables that were due within 12 months. So its liabilities total US$733.0m more than the combination of its cash and short-term receivables.
This deficit isn’t so bad because G-III Apparel Group is worth US$1.46b, and thus could probably raise enough capital to shore up its balance sheet, if the need arose. But we definitely want to keep our eyes open to indications that its debt is bringing too much risk. Either way, since G-III Apparel Group does have more debt than cash, it’s worth keeping an eye on its balance sheet.
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). 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 1.32 suggests only modest use of debt, the fact that EBIT only covered the interest expense by 5.27 last year does give us pause. But the interest payments are certainly sufficient to have us thinking about how affordable its debt is. Also relevant is that G-III Apparel Group has grown its EBIT by a very respectable 24% in the last year, thus enhancing its ability to pay down debt. There’s no doubt that we learn most about debt from the balance sheet. But ultimately the future profitability of the business will decide if G-III Apparel Group can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.
But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. In the last three years, G-III Apparel Group’s free cash flow amounted to 32% of its EBIT, less than we’d expect. That’s not great, when it comes to paying down debt.
When it comes to the balance sheet, the standout positive for G-III Apparel Group was the fact that it seems able to grow its EBIT confidently. However, our other observations weren’t so heartening. For instance it seems like it has to struggle a bit to convert EBIT to free cash flow. Looking at all this data makes us feel a little cautious about G-III Apparel Group’s debt levels. While we appreciate debt can enhance returns on equity, we’d suggest that shareholders keep close watch on its debt levels, lest they increase. We’d be motivated to research the stock further if we found out that G-III Apparel Group insiders have bought shares recently. If you would too, then you’re in luck, since today we’re sharing our list of reported insider transactions for free.
Of course, if you’re the type of investor who prefers buying stocks without the burden of debt, then don’t hesitate to discover our exclusive list of net cash growth stocks, today.
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If you spot an error that warrants correction, please contact the editor at email@example.com. This article by Simply Wall St is general in nature. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. Simply Wall St has no position in the stocks mentioned. Thank you for reading.