Warren Buffett famously said, 'Volatility is far from synonymous with risk.' 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. We note that PFSweb, Inc. (NASDAQ:PFSW) does have debt on its balance sheet. But is this debt a concern to shareholders?
When Is Debt Dangerous?
Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. If things get really bad, the lenders can take control of the business. 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. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. When we examine debt levels, we first consider both cash and debt levels, together.
What Is PFSweb's Net Debt?
The image below, which you can click on for greater detail, shows that PFSweb had debt of US$34.7m at the end of June 2019, a reduction from US$45.9m over a year. On the flip side, it has US$11.8m in cash leading to net debt of about US$22.8m.
How Strong Is PFSweb's Balance Sheet?
Zooming in on the latest balance sheet data, we can see that PFSweb had liabilities of US$71.8m due within 12 months and liabilities of US$72.3m due beyond that. On the other hand, it had cash of US$11.8m and US$56.4m worth of receivables due within a year. So its liabilities total US$75.8m more than the combination of its cash and short-term receivables.
This deficit casts a shadow over the US$48.6m company, like a colossus towering over mere mortals. So we'd watch its balance sheet closely, without a doubt After all, PFSweb would likely require a major re-capitalisation if it had to pay its creditors today.
We use two main ratios to inform us about debt levels relative to earnings. The first is net debt divided by earnings before interest, tax, depreciation, and amortization (EBITDA), while the second is how many times its earnings before interest and tax (EBIT) covers its interest expense (or its interest cover, for short). The advantage of this approach is that we take into account both the absolute quantum of debt (with net debt to EBITDA) and the actual interest expenses associated with that debt (with its interest cover ratio).
Given net debt is only 1.5 times EBITDA, it is initially surprising to see that PFSweb's EBIT has low interest coverage of 2.0 times. So while we're not necessarily alarmed we think that its debt is far from trivial. Shareholders should be aware that PFSweb's EBIT was down 32% last year. If that decline continues then paying off debt will be harder than selling foie gras at a vegan convention. 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 PFSweb can strengthen its balance sheet over time. 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. So it's worth checking how much of that EBIT is backed by free cash flow. Over the last two years, PFSweb actually produced more free cash flow than EBIT. That sort of strong cash conversion gets us as excited as the crowd when the beat drops at a Daft Punk concert.
On the face of it, PFSweb's level of total liabilities left us tentative about the stock, and its EBIT growth rate was no more enticing than the one empty restaurant on the busiest night of the year. But on the bright side, its conversion of EBIT to free cash flow is a good sign, and makes us more optimistic. We're quite clear that we consider PFSweb to be really rather risky, as a result of its balance sheet health. So we're almost as wary of this stock as a hungry kitten is about falling into its owner's fish pond: once bitten, twice shy, as they say. In light of our reservations about the company's balance sheet, it seems sensible to check if insiders have been selling shares recently.
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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