Is e.l.f. Beauty (NYSE:ELF) A Risky Investment?

Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' 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. As with many other companies e.l.f. Beauty, Inc. (NYSE:ELF) makes use of debt. But should shareholders be worried about its use of debt?

Why Does Debt Bring Risk?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. 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. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

See our latest analysis for e.l.f. Beauty

What Is e.l.f. Beauty's Debt?

As you can see below, e.l.f. Beauty had US$62.7m of debt at September 2023, down from US$93.1m a year prior. However, its balance sheet shows it holds US$167.8m in cash, so it actually has US$105.0m net cash.

How Healthy Is e.l.f. Beauty's Balance Sheet?

We can see from the most recent balance sheet that e.l.f. Beauty had liabilities of US$152.4m falling due within a year, and liabilities of US$78.1m due beyond that. Offsetting this, it had US$167.8m in cash and US$86.7m in receivables that were due within 12 months. So it actually has US$23.9m more liquid assets than total liabilities.

Having regard to e.l.f. Beauty's size, it seems that its liquid assets are well balanced with its total liabilities. So while it's hard to imagine that the US$8.70b 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 176% over twelve months. That boost will make it even easier to pay down debt going forward. When analysing debt levels, the balance sheet is the obvious place to start. 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 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. 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 91% of its EBIT, more than we'd expect. That puts it in a very strong position to pay down debt.

Summing Up

While it is always sensible to investigate a company's debt, in this case e.l.f. Beauty has US$105.0m in net cash and a decent-looking balance sheet. And it impressed us with free cash flow of US$108m, being 91% 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. For instance, we've identified 2 warning signs for e.l.f. Beauty that 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.