David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the 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. Importantly, Superior Group of Companies, Inc. (NASDAQ:SGC) does carry debt. 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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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. Of course, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. When we think about a company's use of debt, we first look at cash and debt together.
What Is Superior Group of Companies's Debt?
The image below, which you can click on for greater detail, shows that at March 2021 Superior Group of Companies had debt of US$109.1m, up from US$101.1m in one year. However, it also had US$10.9m in cash, and so its net debt is US$98.2m.
How Strong Is Superior Group of Companies' Balance Sheet?
Zooming in on the latest balance sheet data, we can see that Superior Group of Companies had liabilities of US$91.0m due within 12 months and liabilities of US$122.6m due beyond that. Offsetting these obligations, it had cash of US$10.9m as well as receivables valued at US$146.1m due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by US$56.6m.
Of course, Superior Group of Companies has a market capitalization of US$401.9m, so these liabilities are probably manageable. But there are sufficient liabilities that we would certainly recommend shareholders continue to monitor the balance sheet, going forward.
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).
Superior Group of Companies's net debt is only 1.3 times its EBITDA. And its EBIT easily covers its interest expense, being 52.8 times the size. So you could argue it is no more threatened by its debt than an elephant is by a mouse. Better yet, Superior Group of Companies grew its EBIT by 201% last year, which is an impressive improvement. If maintained that growth will make the debt even more manageable in the years ahead. 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 Superior Group of Companies 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.
But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So we always check how much of that EBIT is translated into free cash flow. In the last three years, Superior Group of Companies's free cash flow amounted to 43% of its EBIT, less than we'd expect. That's not great, when it comes to paying down debt.
Happily, Superior Group of Companies's impressive interest cover implies it has the upper hand on its debt. And that's just the beginning of the good news since its EBIT growth rate is also very heartening. Taking all this data into account, it seems to us that Superior Group of Companies takes a pretty sensible approach to debt. That means they are taking on a bit more risk, in the hope of boosting shareholder returns. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. Be aware that Superior Group of Companies is showing 2 warning signs in our investment analysis , and 1 of those makes us a bit uncomfortable...
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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