Duluth Holdings (NASDAQ:DLTH) Seems To Use Debt Quite Sensibly

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.' 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. We can see that Duluth Holdings Inc. (NASDAQ:DLTH) does use debt in its business. But the more important question is: how much risk is that debt creating?

Why Does Debt Bring Risk?

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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. When we think about a company's use of debt, we first look at cash and debt together.

View our latest analysis for Duluth Holdings

What Is Duluth Holdings's Debt?

As you can see below, Duluth Holdings had US$27.2m of debt at May 2022, down from US$45.3m a year prior. However, it does have US$40.4m in cash offsetting this, leading to net cash of US$13.2m.

How Healthy Is Duluth Holdings' Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Duluth Holdings had liabilities of US$108.2m due within 12 months and liabilities of US$173.3m due beyond that. Offsetting these obligations, it had cash of US$40.4m as well as receivables valued at US$6.95m due within 12 months. So its liabilities total US$234.1m more than the combination of its cash and short-term receivables.

This deficit is considerable relative to its market capitalization of US$318.3m, so it does suggest shareholders should keep an eye on Duluth Holdings' use of debt. This suggests shareholders would be heavily diluted if the company needed to shore up its balance sheet in a hurry. While it does have liabilities worth noting, Duluth Holdings also has more cash than debt, so we're pretty confident it can manage its debt safely.

On the other hand, Duluth Holdings saw its EBIT drop by 4.6% in the last twelve months. If earnings continue to decline at that rate the company may have increasing difficulty managing its debt load. There's no doubt that we learn most about debt from the balance sheet. But it is future earnings, more than anything, that will determine Duluth Holdings'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.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. Duluth Holdings 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. Over the last three years, Duluth Holdings recorded free cash flow worth a fulsome 81% of its EBIT, which is stronger than we'd usually expect. That puts it in a very strong position to pay down debt.

Summing up

While Duluth Holdings does have more liabilities than liquid assets, it also has net cash of US$13.2m. The cherry on top was that in converted 81% of that EBIT to free cash flow, bringing in US$36m. So we are not troubled with Duluth Holdings's debt use. 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. For instance, we've identified 1 warning sign for Duluth Holdings that 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.