Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk.' 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. We can see that e.l.f. Beauty, Inc. (NYSE:ELF) does use debt in its business. 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 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we examine debt levels, we first consider both cash and debt levels, together.
Check out our latest analysis for e.l.f. Beauty
What Is e.l.f. Beauty's Debt?
The image below, which you can click on for greater detail, shows that e.l.f. Beauty had debt of US$64.6m at the end of June 2023, a reduction from US$94.3m over a year. However, its balance sheet shows it holds US$142.5m in cash, so it actually has US$77.9m net cash.
How Healthy Is e.l.f. Beauty's Balance Sheet?
Zooming in on the latest balance sheet data, we can see that e.l.f. Beauty had liabilities of US$109.7m due within 12 months and liabilities of US$76.5m due beyond that. Offsetting these obligations, it had cash of US$142.5m as well as receivables valued at US$90.5m due within 12 months. So it can boast US$46.9m more liquid assets than total liabilities.
This state of affairs indicates that e.l.f. Beauty's balance sheet looks quite solid, as its total liabilities are just about equal to its liquid assets. So while it's hard to imagine that the US$5.82b company is struggling for cash, we still think it's worth monitoring its balance sheet. Succinctly put, e.l.f. Beauty boasts net cash, so it's fair to say it does not have a heavy debt load!
Even more impressive was the fact that e.l.f. Beauty grew its EBIT by 168% over twelve months. If maintained that growth will make the debt even more manageable in the years ahead. 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 e.l.f. Beauty'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. e.l.f. Beauty may have net cash on the balance sheet, but it is still interesting to look at how well the business converts its earnings before interest and tax (EBIT) to free cash flow, because that will influence both its need for, and its capacity to manage debt. During the last three years, e.l.f. Beauty generated free cash flow amounting to a very robust 89% of its EBIT, more than we'd expect. That positions it well to pay down debt if desirable to do so.
Summing Up
While we empathize with investors who find debt concerning, you should keep in mind that e.l.f. Beauty has net cash of US$77.9m, as well as more liquid assets than liabilities. And it impressed us with free cash flow of US$93m, being 89% of its EBIT. So we don't think e.l.f. Beauty's use of debt is risky. 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. These risks can be hard to spot. Every company has them, and we've spotted 2 warning signs for e.l.f. Beauty you should know about.
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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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.
About NYSE:ELF
High growth potential with excellent balance sheet.
