The Debt Dogs of Retail

Charlie Munger, Warren Buffett's business partner, has condemned drugs, liquor, and leverage as humanity's three biggest downfalls. The first two are your own responsibility, but if you're invested -- or are thinking about investing -- in the retail industry, you should know which companies in the space are the deepest in debt.

Leverage is not inherently bad for a company. A fast-growing company can intelligently employ debt to exploit its market opportunity. At low interest rates, debt can fund shrewd strategic acquisitions. Since it's generally cheaper than equity, debt can also lower a company's cost of capital.

But too often, companies end up abusing debt -- and as Munger reminds us, excessive leverage can lead to ruin. Let's examine a few of the most heavily indebted retailers.

Company

Total Debt/Capital

Interest Coverage

AutoZone (NYSE: AZO  )

139.6%

8.4

Sally Beauty (NYSE: SBH  )

133.6%

3.2

Bon-Ton Stores (Nasdaq: BONT  )

92.9%

1.2

Overstock.com (Nasdaq: OSTK  )

77.8%

2.7

Sonic Automotive (NYSE: SAH  )

77.6%

2.0

First of all, look at the total debt-to-capital ratios for AutoZone and Sally Beauty. Both of these companies have negative equity -- that is, negative book value. They don't have enough assets, as measured on their books, to sell off if they had to pay off their debts tomorrow.

Bon-Ton is one to watch out for. With an enterprise value to EBITDA multiple of just 5.7, it is likely showing up on value-oriented screens; however, with an interest coverage of 1.2, the company is struggling to make enough money just to cover its interest payments.

Overstock.com stands out on this because even though a high percentage of its capital is in debt, the company is the only one on the list to boast more cash on its book than debt. This $322 million company has $76 million in cash and just $50 million in debt. Also, because it is an online retailer, we wouldn't expect the company to have much in the way of hard assets (i.e., stores), so the higher debt level might not be as much as a concern here.

Sonic Automotive's numbers, on the other hand, might be going too easy on the company. Though its debt-to-capital ratio clocks in about the same as Overstock.com's, this $759 million market cap company has a whopping $1,369 million in debt and just $11 million in cash. Further, its interest coverage is a low 2.7, meaning that half of its operating income is going to pay off the interest on all that debt.

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Neither Alex Pape nor the Fool owns shares of any company mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.


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