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Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. Importantly, Crown Crafts, Inc. (NASDAQ:CRWS) does carry debt. But the real question is whether this debt is making the company risky.
When Is Debt A Problem?
Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. 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, debt can be an important tool in businesses, particularly capital heavy businesses. The first step when considering a company's debt levels is to consider its cash and debt together.
What Is Crown Crafts's Net Debt?
You can click the graphic below for the historical numbers, but it shows that as of December 2020 Crown Crafts had US$1.96m of debt, an increase on none, over one year. However, its balance sheet shows it holds US$3.66m in cash, so it actually has US$1.69m net cash.
A Look At Crown Crafts' Liabilities
Zooming in on the latest balance sheet data, we can see that Crown Crafts had liabilities of US$17.2m due within 12 months and liabilities of US$6.17m due beyond that. Offsetting these obligations, it had cash of US$3.66m as well as receivables valued at US$18.2m due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by US$1.46m.
Having regard to Crown Crafts' size, it seems that its liquid assets are well balanced with its total liabilities. So while it's hard to imagine that the US$77.4m company is struggling for cash, we still think it's worth monitoring its balance sheet. While it does have liabilities worth noting, Crown Crafts also has more cash than debt, so we're pretty confident it can manage its debt safely.
Also positive, Crown Crafts grew its EBIT by 21% in the last year, and that should make it easier to pay down debt, going forward. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Crown Crafts's ability to maintain a healthy balance sheet going forward. So if you're focused on the future you can check out this free report showing analyst profit forecasts.
Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. Crown Crafts 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. Over the most recent three years, Crown Crafts recorded free cash flow worth 67% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This free cash flow puts the company in a good position to pay down debt, when appropriate.
We could understand if investors are concerned about Crown Crafts's liabilities, but we can be reassured by the fact it has has net cash of US$1.69m. And we liked the look of last year's 21% year-on-year EBIT growth. So is Crown Crafts's debt a risk? It doesn't seem so to us. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. Case in point: We've spotted 3 warning signs for Crown Crafts you should be aware of, and 1 of them can't be ignored.
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.
This article by Simply Wall St is general in nature. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.
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