Howard Marks said it well when he stated that rather than worrying about volatility in share prices, ‘The risk of permanent loss is what I worry about… and everyone practical investor I know worries. The smart money seems to know that debt – which is often involved with bankruptcies- is a very important aspect of evaluating how risky an organization is. Importantly, Sally Beauty Holdings, Inc.(NYSE:SBH), has debt. The real question is if this debt is making the company more risky.
What is the danger of having debt?
A business can borrow money to help pay it off until it has difficulty paying it off. This can be done with either new capital or free cash flow. Part of capitalism is the process known as ‘creative destruction’ in which failed businesses are ruthlessly liquidated by their banks. A more common, but still costly, situation is when a company must dilute shareholders at low share prices to keep its debt under control. Businesses that require capital to grow at high rates can use debt to replace dilution. When assessing how much debt a company has, the first thing you should do is to examine its cash and debt together.
What Is Sally Beauty Holdings’s Debt?
Below you can see that Sally Beauty Holdings was down to US$1.38b in debt as of June 2022. It did have US$101.3m of cash and its net debt was US$982.6m.
Sally Beauty Holdings’ Liabilities
The most recent balance sheet shows that Sally Beauty Holdings had US$775.0m of liabilities due within one year and US$1.62b beyond that. These obligations were offset by cash of US$101.3m and receivables of US$67.4m that are due within 12 months. The total liabilities of the company are US$2.22b higher than the sum of its cash and short-term receipts.
If you consider that the deficiency is greater than the company’s US$1.55b in market capitalization, it might be a good idea to carefully review the balance sheet. If the company had to quickly clean up its balance sheets, it is likely that shareholders would suffer significant dilution.
Two main ratios are used to determine the debt level relative to earnings. The first is net debt divided with earnings before interest tax, depreciation and amortization (EBITDA), and the second is how much its earnings before tax and interest (EBIT) cover its interest expense (or its “interest cover”). We take into account both the absolute quantity of the debt as well as the interest rates.
Sally Beauty Holdings’s net credit is a reasonable 1.9 times EBITDA. However, its EBIT only covered its interest expense 4.3 times last fiscal year. These numbers are not alarming, but it is worth noting that the company’s debt has a real impact. Sally Beauty Holdings’ EBIT grew by 4.5% over the last year. While this is not a huge improvement in terms of debt, it is still a positive. It is clear that the balance sheet is the best place to learn about debt. Sally Beauty Holdings’s ability maintain a healthy balance will be determined by future earnings. You might be interested in what the pros think. This report is free and contains information about analyst profit predictionsto be interesting.
Finally, the tax-man may love accounting profits but lenders only take hard cash. It is important to evaluate whether EBIT is producing corresponding free money flow. Sally Beauty Holdings has recorded free cash flow of 62% over the last three years. This is about normal, as interest and tax are not included in free cash flow. The company has the ability to pay down any debts that it needs with this free cash flow.
We aren’t enthusiastic about Sally Beauty Holdings trying to stay on top of its total liabilities. It’s still pretty good at converting EBIT into free cash flow, which is encouraging. We believe that Sally Beauty Holdings stock is a bit too risky based on the balance sheet and all of these factors. While some people enjoy this level of risk, we are aware of the potential pitfalls and would prefer that it be less. The balance sheet is where we learn the most about debt. But every company can have risks that aren’t in the balance sheets. We have identified 1 warning sign Sally Beauty Holdings Understanding them is an important part of your investment process.
If you are an investor who prefers to buy stocks without the burden of borrowing, then don’t be afraid to explore. Our exclusive list of net cash-growth stocks, today.
Give feedback on this article Are you concerned about the content? Get in touchContact us directly. Alternatively, email editorial-team (at) simplywallst.com.
This article by Simply Wall St has a general nature. Our commentary is based on historical data and analyst projections. We do not intend to provide financial advice.This analysis does not represent a recommendation to purchase or sell any stock and does not consider your financial situation or objectives. We strive to provide you with long-term, focused analysis based on fundamental data. Our analysis may not take into account the most recent price-sensitive company announcements and qualitative material. Simply Wall St holds no position in any of these stocks.
These views and opinions are solely the author’s and do not necessarily reflect the views of Nasdaq, Inc.