Warren Buffett said: “Volatility is far from synonymous with risk”. So it seems like smart money knows that debt – which is usually involved in bankruptcies – is a very important factor, when you assess the level of risk of a business. We can see that Select Interior Concepts, Inc. (NASDAQ: SIC) uses debt in his business. But should shareholders be concerned on how to file bankruptcy and about its use of debt?
When is debt dangerous?
Debts and other liabilities become risky for a business when it cannot easily meet these obligations, either with free cash flow or by raising capital at an attractive price. In the worst case scenario, a business can go bankrupt if it cannot pay its creditors. However, a more common (but still costly) situation is where a company has to dilute its shareholders at a cheap share price just to get its debt under control. Of course, debt can be an important tool in businesses, especially capital intensive businesses. When we think of a business’s use of debt, we first look at cash flow and debt together.
What is Select Interior Concepts’ net debt?
You can click on the graph below for historical figures, but it shows Select Interior Concepts owed $ 159.9 million in debt as of September 2020, up from $ 188.1 million a year earlier. However, given that it has a cash reserve of US $ 4.10 million, its net debt is less, at around US $ 155.8 million.
How strong is Select Interior Concepts’ balance sheet?
The latest balance sheet data shows that Select Interior Concepts had liabilities of US $ 80.8 million due within one year, and liabilities of US $ 172.9 million due thereafter. On the other hand, he had cash of US $ 4.10 million and US $ 85.4 million in receivables due within a year. It therefore has a liability totaling US $ 164.2 million more than its cash and short-term receivables combined.
This shortfall is sizable compared to its market cap of $ 210.5 million, so he suggests shareholders keep an eye on Select Interior Concepts’ use of debt. If its lenders asked it to consolidate the balance sheet, shareholders would likely face severe dilution.
In order to measure a company’s debt relative to its profits, we calculate its net debt divided by its earnings before interest, taxes, depreciation and amortization (EBITDA) and its profit before interest and taxes (EBIT) divided by its interest. debtors (its interest coverage). Thus, we consider debt versus earnings with and without amortization expenses.
The shareholders of Select Interior Concepts are faced with the double whammy of a high net debt / EBITDA ratio (5.4) and relatively low interest coverage, since EBIT is only 0.41 times the interest charges. The debt burden here is considerable. Worse, Select Interior Concepts’ EBIT was down 71% from last year. If profits continue to follow this path, it will be more difficult to pay off this debt than to convince us to run a marathon in the rain. The balance sheet is clearly the area to focus on when analyzing debt. But ultimately, the company’s future profitability will decide whether Select Interior Concepts can strengthen its balance sheet over time. So if you want to see what the professionals are thinking, you might find this free report on analysts’ earnings forecasts Be interesting.
But our last consideration is also important, because a business cannot pay its debts with paper profits; he needs hard cash. It is therefore worth checking to what extent this EBIT is supported by free cash flow. Fortunately for all shareholders, Select Interior Concepts has actually generated more free cash flow than EBIT over the past three years. This kind of solid money generation warms our hearts like a puppy in a bumblebee costume.
Our point of view
At first glance, Select Interior Concepts’ interest hedging left us hesitant about the stock, and its EBIT growth rate was no more attractive than the single empty restaurant on the busiest night of the year. But on the positive side, its conversion from EBIT to free cash flow is a good sign and makes us more optimistic. Overall, we think it’s fair to say that Select Interior Concepts has enough debt that there is real risk around the balance sheet. If all goes well, this should increase returns, but on the other hand, the risk of permanent capital loss is increased by debt. Given our hesitation on the stock, it would be nice to know if Select Interior Concepts insiders have sold any shares recently. You click here to see if any insiders have sold recently.
If you want to invest in companies that can generate profits without the burden of debt, check out this free list of growing companies that have net cash on the balance sheet.
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