David Iben put it well when he said, ‘Volatility is not a risk we care about. What we care about is avoiding the permanent loss of capital.’ So it seems the smart money knows that debt – which is usually involved in bankruptcies – is a very important factor, when you assess how risky a company is. Importantly, Hanesbrands Inc. (NYSE:HBI) does carry debt. But the real question is whether this debt is making the company risky.
When Is Debt Dangerous?
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. Ultimately, if the company can’t fulfill its legal obligations to repay debt, shareholders could walk away with nothing. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. 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.
How Much Debt Does Hanesbrands Carry?
As you can see below, Hanesbrands had US$3.68b of debt at July 2021, down from US$4.11b a year prior. However, it does have US$667.3m in cash offsetting this, leading to net debt of about US$3.02b.
How Healthy Is Hanesbrands’ Balance Sheet?
Zooming in on the latest balance sheet data, we can see that Hanesbrands had liabilities of US$2.26b due within 12 months and liabilities of US$4.46b due beyond that. Offsetting this, it had US$667.3m in cash and US$961.0m in receivables that were due within 12 months. So it has liabilities totalling US$5.09b more than its cash and near-term receivables, combined.
This deficit is considerable relative to its market capitalization of US$5.88b, so it does suggest shareholders should keep an eye on Hanesbrands’ use of debt. Should its lenders demand that it shore up the balance sheet, shareholders would likely face severe dilution.
We measure a company’s debt load relative to its earnings power by looking at its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and by calculating how easily its earnings before interest and tax (EBIT) cover its interest expense (interest cover). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.
Hanesbrands has a debt to EBITDA ratio of 2.9 and its EBIT covered its interest expense 5.2 times. This suggests that while the debt levels are significant, we’d stop short of calling them problematic. If Hanesbrands can keep growing EBIT at last year’s rate of 12% over the last year, then it will find its debt load easier to manage. 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 Hanesbrands 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.
But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. During the last three years, Hanesbrands produced sturdy free cash flow equating to 73% of its EBIT, about what we’d expect. This cold hard cash means it can reduce its debt when it wants to.
On our analysis Hanesbrands’s conversion of EBIT to free cash flow should signal that it won’t have too much trouble with its debt. However, our other observations weren’t so heartening. For example, its level of total liabilities makes us a little nervous about its debt. When we consider all the factors mentioned above, we do feel a bit cautious about Hanesbrands’s use of debt. While debt does have its upside in higher potential returns, we think shareholders should definitely consider how debt levels might make the stock more risky. The balance sheet is clearly the area to focus on when you are analysing debt.