Warren Buffett famously said, '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. As with many other companies Duluth Holdings Inc. (NASDAQ:DLTH) makes use of debt. 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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.
What Is Duluth Holdings's Debt?
The image below, which you can click on for greater detail, shows that Duluth Holdings had debt of US$27.2m at the end of May 2022, a reduction from US$45.3m over a year. However, its balance sheet shows it holds US$40.4m in cash, so it actually has US$13.2m net cash.
How Healthy Is Duluth Holdings' Balance Sheet?
The latest balance sheet data shows that Duluth Holdings had liabilities of US$108.2m due within a year, and liabilities of US$173.3m falling due after 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 outweigh the sum of its cash and (near-term) receivables by US$234.1m.
This is a mountain of leverage relative to its market capitalization of US$299.9m. 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 company can only pay off debt with cold hard cash, not accounting profits. While Duluth Holdings has net cash on its balance sheet, it's still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. During the last three years, Duluth Holdings generated free cash flow amounting to a very robust 81% of its EBIT, more than we'd 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. And it impressed us with free cash flow of US$36m, being 81% of its EBIT. So we are not troubled with Duluth Holdings's debt use. Over time, share prices tend to follow earnings per share, so if you're interested in Duluth Holdings, you may well want to click here to check an interactive graph of its earnings per share history.
When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.
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