The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. As with many other companies Lakeland Industries, Inc. (NASDAQ:LAKE) makes use of debt. But the real question is whether this debt is making the company risky.
When Is Debt Dangerous?
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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. The first step when considering a company's debt levels is to consider its cash and debt together.
What Is Lakeland Industries's Debt?
You can click the graphic below for the historical numbers, but it shows that Lakeland Industries had US$1.48m of debt in April 2019, down from US$1.61m, one year before. But it also has US$14.3m in cash to offset that, meaning it has US$12.8m net cash.
How Healthy Is Lakeland Industries's Balance Sheet?
According to the last reported balance sheet, Lakeland Industries had liabilities of US$16.0m due within 12 months, and liabilities of US$2.68m due beyond 12 months. On the other hand, it had cash of US$14.3m and US$15.6m worth of receivables due within a year. So it can boast US$11.2m more liquid assets than total liabilities.
This surplus suggests that Lakeland Industries has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Simply put, the fact that Lakeland Industries has more cash than debt is arguably a good indication that it can manage its debt safely.
In fact Lakeland Industries's saving grace is its low debt levels, because its EBIT has tanked 73% in the last twelve months. When a company sees its earnings tank, it can sometimes find its relationships with its lenders turn sour. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Lakeland Industries'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. Lakeland Industries may have net cash on the balance sheet, but it is still interesting to look at how well the business converts its earnings before interest and tax (EBIT) to free cash flow, because that will influence both its need for, and its capacity to manage debt. In the last three years, Lakeland Industries's free cash flow amounted to 37% of its EBIT, less than we'd expect. That's not great, when it comes to paying down debt.
While we empathize with investors who find debt concerning, you should keep in mind that Lakeland Industries has net cash of US$13m, as well as more liquid assets than liabilities. So we don't have any problem with Lakeland Industries's use of debt. We'd be motivated to research the stock further if we found out that Lakeland Industries insiders have bought shares recently. If you would too, then you're in luck, since today we're sharing our list of reported insider transactions for free.
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.
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