Is Sportsman's Warehouse Holdings (NASDAQ:SPWH) Using Too Much Debt?

Warren Buffett famously said, '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 Sportsman's Warehouse Holdings, Inc. (NASDAQ:SPWH) does use debt in its business. 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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. 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 Sportsman's Warehouse Holdings

What Is Sportsman's Warehouse Holdings's Debt?

The image below, which you can click on for greater detail, shows that Sportsman's Warehouse Holdings had debt of US$28.3m at the end of October 2020, a reduction from US$174.5m over a year. However, because it has a cash reserve of US$19.3m, its net debt is less, at about US$9.02m.

A Look At Sportsman's Warehouse Holdings' Liabilities

According to the last reported balance sheet, Sportsman's Warehouse Holdings had liabilities of US$283.4m due within 12 months, and liabilities of US$239.4m due beyond 12 months. Offsetting these obligations, it had cash of US$19.3m as well as receivables valued at US$462.0k due within 12 months. So its liabilities total US$503.1m more than the combination of its cash and short-term receivables.

This is a mountain of leverage relative to its market capitalization of US$763.3m. This suggests shareholders would be heavily diluted if the company needed to shore up its balance sheet in a hurry. Carrying virtually no net debt, Sportsman's Warehouse Holdings has a very light debt load indeed.

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). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

Sportsman's Warehouse Holdings has very little debt (net of cash), and boasts a debt to EBITDA ratio of 0.073 and EBIT of 22.7 times the interest expense. Indeed relative to its earnings its debt load seems light as a feather. Even more impressive was the fact that Sportsman's Warehouse Holdings grew its EBIT by 173% over twelve months. If maintained that growth will make the debt even more manageable in the years ahead. 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 Sportsman's Warehouse Holdings'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, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. Over the last three years, Sportsman's Warehouse Holdings actually produced more free cash flow than EBIT. That sort of strong cash conversion gets us as excited as the crowd when the beat drops at a Daft Punk concert.

Our View

Happily, Sportsman's Warehouse Holdings's impressive interest cover implies it has the upper hand on its debt. But, on a more sombre note, we are a little concerned by its level of total liabilities. Zooming out, Sportsman's Warehouse Holdings seems to use debt quite reasonably; and that gets the nod from us. After all, sensible leverage can boost returns on equity. 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. Like risks, for instance. Every company has them, and we've spotted 2 warning signs for Sportsman's Warehouse Holdings (of which 1 is potentially serious!) you should know about.

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.

When trading Sportsman's Warehouse Holdings or any other investment, use the platform considered by many to be the Professional's Gateway to the Worlds Market, Interactive Brokers. You get the lowest-cost* trading on stocks, options, futures, forex, bonds and funds worldwide from a single integrated account. Promoted

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.
^*Interactive Brokers Rated Lowest Cost Broker by StockBrokers.com Annual Online Review 2020

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.