Warren Buffett said: “Volatility is far from synonymous with risk. When we think of a company’s risk, we always like to look at its use of debt, because over-indebtedness can lead to ruin. Above all, elf Beauty, Inc. (NYSE:ELF) is in debt. But should shareholders worry about its use of debt?
When is debt a problem?
Debt and other liabilities become risky for a business when it cannot easily meet those obligations, either with free cash flow or by raising capital at an attractive price. An integral part of capitalism is the process of “creative destruction” where bankrupt companies are mercilessly liquidated by their bankers. However, a more frequent (but still costly) event is when a company has to issue shares at bargain prices, permanently diluting shareholders, just to shore up its balance sheet. Of course, debt can be an important tool in businesses, especially capital-intensive businesses. When we look at debt levels, we first consider cash and debt levels, together.
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What is elf Beauty’s debt?
You can click on the chart below for historical numbers, but it shows elf Beauty had $95.4 million in debt in March 2022, up from $124.3 million a year prior. However, he also had $43.4 million in cash, so his net debt is $52.1 million.
How strong is elf Beauty’s balance sheet?
The latest balance sheet data shows that elf Beauty had liabilities of $65.0 million due within the year, and liabilities of $117.2 million due thereafter. On the other hand, it had liquidities of 43.4 million dollars and 45.6 million dollars of receivables within one year. It therefore has liabilities totaling $93.3 million more than its cash and short-term receivables, combined.
Of course, elf Beauty has a market cap of US$1.65 billion, so those liabilities are probably manageable. But there are enough liabilities that we certainly recommend that shareholders continue to monitor the balance sheet in the future.
In order to assess a company’s debt relative to its earnings, we calculate its net debt divided by its earnings before interest, taxes, depreciation and amortization (EBITDA) and its earnings before interest and taxes (EBIT) divided by its expenses. interest (its interest coverage). Thus, we consider debt to earnings with and without amortization and depreciation expense.
elf Beauty has a low net debt to EBITDA ratio of just 1.0. And its EBIT covers its interest charges 12.2 times. So we’re pretty relaxed about his super-conservative use of debt. Even more impressively, elf Beauty increased its EBIT by 148% year-over-year. This boost will make it even easier to pay off debt in the future. When analyzing debt levels, the balance sheet is the obvious starting point. But it is future earnings, more than anything, that will determine elf Beauty’s ability to maintain a healthy balance sheet in the future. So if you are focused on the future, you can check out this free report showing analyst earnings forecast.
Finally, a company can only repay its debts with cold hard cash, not with book profits. We therefore always check how much of this EBIT is converted into free cash flow. Over the past three years, elf Beauty has actually produced more free cash flow than EBIT. This kind of high cash conversion gets us as excited as the crowd when the beat drops at a Daft Punk concert.
Our point of view
Luckily, elf Beauty’s impressive interest coverage means she has the upper hand on her debt. And this is only the beginning of good news since its conversion of EBIT into free cash flow is also very pleasing. It seems the elven beauty has no trouble standing tall, and she has no reason to fear her lenders. In our view, he has a healthy and happy record. There is no doubt that we learn the most about debt from the balance sheet. However, not all investment risks reside on the balance sheet, far from it. These risks can be difficult to spot. Every business has them, and we’ve spotted 2 warning signs for elven beauty you should know.
Of course, if you’re the type of investor who prefers to buy stocks without the burden of debt, then feel free to check out our exclusive list of cash-efficient growth stocks today.
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This Simply Wall St article is general in nature. We provide commentary based on historical data and analyst forecasts only using unbiased methodology and our articles are not intended to be financial advice. It is not a recommendation to buy or sell stocks and does not take into account your objectives or financial situation. Our goal is to bring you targeted long-term analysis based on fundamental data. Note that our analysis may not take into account the latest announcements from price-sensitive companies or qualitative materials. Simply Wall St has no position in the stocks mentioned.