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.' 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. We note that Culp, Inc. (NYSE:CULP) does have debt on its balance sheet. But is this debt a concern to shareholders?
When Is Debt A Problem?
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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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 thing to do when considering how much debt a business uses is to look at its cash and debt together.
What Is Culp's Debt?
You can click the graphic below for the historical numbers, but it shows that as of April 2019 Culp had US$675.0k of debt, an increase on none, over one year. But it also has US$45.0m in cash to offset that, meaning it has US$44.3m net cash.
How Healthy Is Culp's Balance Sheet?
According to the last reported balance sheet, Culp had liabilities of US$35.2m due within 12 months, and liabilities of US$20.3m due beyond 12 months. Offsetting this, it had US$45.0m in cash and US$24.5m in receivables that were due within 12 months. So it can boast US$14.1m more liquid assets than total liabilities.
This short term liquidity is a sign that Culp could probably pay off its debt with ease, as its balance sheet is far from stretched. Simply put, the fact that Culp has more cash than debt is arguably a good indication that it can manage its debt safely.
It is just as well that Culp's load is not too heavy, because its EBIT was down 46% over the last year. When a company sees its earnings tank, it can sometimes find its relationships with its lenders turn sour. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately the future profitability of the business will decide if Culp can strengthen its balance sheet over time. 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 business needs free cash flow to pay off debt; accounting profits just don't cut it. Culp 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, Culp recorded free cash flow worth 72% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This cold hard cash means it can reduce its debt when it wants to.
While it is always sensible to investigate a company's debt, in this case Culp has US$44m in net cash and a decent-looking balance sheet. And it impressed us with free cash flow of US$11m, being 72% of its EBIT. So we are not troubled with Culp's debt use. Over time, share prices tend to follow earnings per share, so if you're interested in Culp, you may well want to click here to check an interactive graph of its earnings per share history.
Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.
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