Crocs (NASDAQ:CROX) has a fairly healthy balance sheet
Howard Marks said it well when he said that, rather than worrying about stock price volatility, “the possibility of permanent loss is the risk I worry about…and that every practical investor that I know is worried”. So it may be obvious that you need to take debt into account when thinking about the risk of a given stock, because too much debt can sink a business. We can see that Crocs, Inc. (NASDAQ:CROX) uses debt in its business. But the more important question is: what risk does this debt create?
What risk does debt carry?
Debt is a tool to help businesses grow, but if a business is unable to repay its lenders, it exists at their mercy. Ultimately, if the company cannot meet its legal debt repayment obligations, shareholders could walk away with nothing. However, a more common (but still painful) scenario is that it has to raise new equity at a low price, thereby permanently diluting shareholders. Of course, the advantage of debt is that it often represents cheap capital, especially when it replaces dilution in a business with the ability to reinvest at high rates of return. When we think about a company’s use of debt, we first look at cash and debt together.
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What is Crocs debt?
You can click on the graph below for historical numbers, but it shows that in June 2022, Crocs had $2.77 billion in debt, up from $386.4 million, on a year. However, he also had $187.4 million in cash, so his net debt is $2.58 billion.
How healthy is Crocs’ balance sheet?
Zooming in on the latest balance sheet data, we can see that Crocs had liabilities of US$602.1 million due within 12 months and liabilities of US$3.49 billion due beyond. As compensation for these obligations, it had cash of US$187.4 million and receivables valued at US$442.5 million due within 12 months. Thus, its liabilities total $3.46 billion more than the combination of its cash and short-term receivables.
This is a mountain of leverage compared to its market capitalization of US$4.43 billion. This suggests shareholders would be heavily diluted if the company needed to shore up its balance sheet quickly.
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.
Crocs’ net debt is 3.0 times its EBITDA, which is high but still reasonable leverage. But its EBIT was around 12.3 times its interest expense, implying that the company isn’t really paying a high cost to maintain that level of leverage. Even if the low cost turns out to be unsustainable, that’s a good sign. Above all, Crocs has increased its EBIT by 68% in the last twelve months, and this growth will make it easier to manage its debt. When analyzing debt levels, the balance sheet is the obvious starting point. But ultimately, the company’s future profitability will decide whether Crocs can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free analyst earnings forecast report interesting.
But our last consideration is also important, because a company cannot pay debt with paper profits; he needs cash. So the logical step is to look at what proportion of that EBIT is actual free cash flow. Over the past three years, Crocs has had free cash flow of 57% of its EBIT, which is about normal, given that free cash flow excludes interest and taxes. This free cash flow puts the company in a good position to repay its debt, should it arise.
Our point of view
Crocs’ ability to cover its interest expense with its EBIT and its rate of EBIT growth has given us comfort in its ability to manage its debt. On the other hand, its level of total liabilities makes us a little less comfortable about its indebtedness. When you consider all of the above, it seems to us that Crocs manages its debt pretty well. But be warned: we believe debt levels are high enough to warrant continued monitoring. The balance sheet is clearly the area to focus on when analyzing debt. But at the end of the day, every business can contain risks that exist outside of the balance sheet. For example, Crocs has 4 warning signs (and 1 which is potentially serious) that we think you should know about.
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.