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 might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. As with many other companies Conn's, Inc. (NASDAQ:CONN) 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. If things get really bad, the lenders can take control of the business. 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, plenty of companies use debt to fund growth, without any negative consequences. When we examine debt levels, we first consider both cash and debt levels, together.
How Much Debt Does Conn's Carry?
The image below, which you can click on for greater detail, shows that at April 2020 Conn's had debt of US$1.17b, up from US$939.2m in one year. However, because it has a cash reserve of US$287.3m, its net debt is less, at about US$880.6m.
How Healthy Is Conn's's Balance Sheet?
Zooming in on the latest balance sheet data, we can see that Conn's had liabilities of US$185.4m due within 12 months and liabilities of US$1.56b due beyond that. Offsetting these obligations, it had cash of US$287.3m as well as receivables valued at US$623.4m due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by US$830.7m.
This deficit casts a shadow over the US$302.7m company, like a colossus towering over mere mortals. So we definitely think shareholders need to watch this one closely. After all, Conn's would likely require a major re-capitalisation if it had to pay its creditors today. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Conn's'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.
In the last year Conn's had negative earnings before interest and tax, and actually shrunk its revenue by 2.4%, to US$1.5b. We would much prefer see growth.
Importantly, Conn's had negative earnings before interest and tax (EBIT), over the last year. Indeed, it lost US$21.5m at the EBIT level. If you consider the significant liabilities mentioned above, we are extremely wary of this investment. Of course, it may be able to improve its situation with a bit of luck and good execution. But we think that is unlikely since it is low on liquid assets, and made a loss of US$19.7m in the last year. So we think this stock is quite risky. We'd prefer to pass. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. Like risks, for instance. Every company has them, and we've spotted 2 warning signs for Conn's (of which 1 is potentially serious!) you should know about.
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. 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.
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