Is Xcel Brands (NASDAQ:XELB) Using Too Much Debt?

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.' 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 Xcel Brands, Inc. (NASDAQ:XELB) does use debt in its business. But the real question is whether this debt is making the company risky.

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. 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, debt can be an important tool in businesses, particularly capital heavy businesses. 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 Xcel Brands

What Is Xcel Brands's Net Debt?

You can click the graphic below for the historical numbers, but it shows that Xcel Brands had US$17.4m of debt in September 2020, down from US$20.7m, one year before. However, it also had US$4.78m in cash, and so its net debt is US$12.6m.

A Look At Xcel Brands' Liabilities

The latest balance sheet data shows that Xcel Brands had liabilities of US$8.29m due within a year, and liabilities of US$31.9m falling due after that. On the other hand, it had cash of US$4.78m and US$8.19m worth of receivables due within a year. So its liabilities total US$27.2m more than the combination of its cash and short-term receivables.

This deficit is considerable relative to its market capitalization of US$35.4m, so it does suggest shareholders should keep an eye on Xcel Brands' use of debt. This suggests shareholders would be heavily diluted if the company needed to shore up its balance sheet in a hurry. There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since Xcel Brands will need earnings to service that debt. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

Over 12 months, Xcel Brands made a loss at the EBIT level, and saw its revenue drop to US$33m, which is a fall of 17%. We would much prefer see growth.

Caveat Emptor

Not only did Xcel Brands's revenue slip over the last twelve months, but it also produced negative earnings before interest and tax (EBIT). Its EBIT loss was a whopping US$3.6m. When we look at that and recall the liabilities on its balance sheet, relative to cash, it seems unwise to us for the company to have any debt. Quite frankly we think the balance sheet is far from match-fit, although it could be improved with time. We would feel better if it turned its trailing twelve month loss of US$7.8m into a profit. In the meantime, we consider the stock very risky. 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 example, we've discovered 3 warning signs for Xcel Brands (1 doesn't sit too well with us!) that you should be aware of before investing here.

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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