Is Carter's (NYSE:CRI) A Risky Investment?

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. Importantly, Carter's, Inc. (NYSE:CRI) does carry debt. But the real question is whether this debt is making the company risky.

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. 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. 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 think about a company's use of debt, we first look at cash and debt together.

View our latest analysis for Carter's

What Is Carter's's Debt?

The chart below, which you can click on for greater detail, shows that Carter's had US$497.7m in debt in June 2024; about the same as the year before. On the flip side, it has US$316.6m in cash leading to net debt of about US$181.1m.

A Look At Carter's' Liabilities

We can see from the most recent balance sheet that Carter's had liabilities of US$527.6m falling due within a year, and liabilities of US$1.02b due beyond that. Offsetting these obligations, it had cash of US$316.6m as well as receivables valued at US$132.4m due within 12 months. So it has liabilities totalling US$1.09b more than its cash and near-term receivables, combined.

Carter's has a market capitalization of US$2.46b, so it could very likely raise cash to ameliorate 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.

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). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

Carter's has a low net debt to EBITDA ratio of only 0.47. And its EBIT covers its interest expense a whopping 14.5 times over. So we're pretty relaxed about its super-conservative use of debt. Fortunately, Carter's grew its EBIT by 7.1% in the last year, making that debt load look even more manageable. 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 Carter's 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 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. During the last three years, Carter's produced sturdy free cash flow equating to 73% of its EBIT, about what we'd expect. This free cash flow puts the company in a good position to pay down debt, when appropriate.

Our View

Happily, Carter's's impressive interest cover implies it has the upper hand on its debt. But truth be told we feel its level of total liabilities does undermine this impression a bit. Taking all this data into account, it seems to us that Carter's takes a pretty sensible approach to debt. While that brings some risk, it can also enhance returns for shareholders. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. For instance, we've identified 2 warning signs for Carter's (1 doesn't sit too well with us) you should be aware of.

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

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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.