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 Burlington Stores, Inc. (NYSE:BURL) does use debt in its business. But should shareholders be worried about its use of debt?
Why Does Debt Bring Risk?
Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. If things get really bad, the lenders can take control of the business. 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. 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. When we think about a company's use of debt, we first look at cash and debt together.
How Much Debt Does Burlington Stores Carry?
As you can see below, Burlington Stores had US$1.45b of debt at July 2022, down from US$1.77b a year prior. However, because it has a cash reserve of US$455.0m, its net debt is less, at about US$990.2m.
A Look At Burlington Stores' Liabilities
According to the last reported balance sheet, Burlington Stores had liabilities of US$1.61b due within 12 months, and liabilities of US$4.49b due beyond 12 months. Offsetting this, it had US$455.0m in cash and US$70.9m in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by US$5.57b.
While this might seem like a lot, it is not so bad since Burlington Stores has a huge market capitalization of US$10.2b, and so it could probably strengthen its balance sheet by raising capital if it needed to. But we definitely want to keep our eyes open to indications that its debt is bringing too much risk.
We use two main ratios to inform us about debt levels relative to earnings. The first is net debt divided by earnings before interest, tax, depreciation, and amortization (EBITDA), while the second is how many times its earnings before interest and tax (EBIT) covers its interest expense (or its interest cover, for short). The advantage of this approach is that we take into account both the absolute quantum of debt (with net debt to EBITDA) and the actual interest expenses associated with that debt (with its interest cover ratio).
Burlington Stores has net debt of just 1.4 times EBITDA, indicating that it is certainly not a reckless borrower. And it boasts interest cover of 8.0 times, which is more than adequate. The modesty of its debt load may become crucial for Burlington Stores if management cannot prevent a repeat of the 33% cut to EBIT over the last year. Falling earnings (if the trend continues) could eventually make even modest debt quite risky. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Burlington Stores can strengthen its balance sheet over time. So if you're focused on the future you can check out this free report showing analyst profit forecasts.
Finally, a company can only pay off debt with cold hard cash, not accounting profits. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. During the last two years, Burlington Stores produced sturdy free cash flow equating to 59% of its EBIT, about what we'd expect. This cold hard cash means it can reduce its debt when it wants to.
Burlington Stores's EBIT growth rate was a real negative on this analysis, although the other factors we considered cast it in a significantly better light. For example, its interest cover is relatively strong. Taking the abovementioned factors together we do think Burlington Stores's debt poses some risks to the business. While that debt can boost returns, we think the company has enough leverage now. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. Be aware that Burlington Stores is showing 3 warning signs in our investment analysis , and 2 of those are a bit concerning...
If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.
What are the risks and opportunities for Burlington Stores?
Earnings are forecast to grow 30.41% per year
Debt is not well covered by operating cash flow
High level of non-cash earnings
Significant insider selling over the past 3 months
Profit margins (1.9%) are lower than last year (4.9%)
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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.