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 Everi Holdings Inc. (NYSE:EVRI) does have debt on its balance sheet. But should shareholders be worried about its use of debt?
What Risk Does Debt Bring?
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. Part and parcel of capitalism is the process of ‘creative destruction’ where failed businesses are mercilessly liquidated by their bankers. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.
What Is Everi Holdings’s Debt?
You can click the graphic below for the historical numbers, but it shows that Everi Holdings had US$982.4m of debt in September 2021, down from US$1.13b, one year before. However, because it has a cash reserve of US$221.3m, its net debt is less, at about US$761.1m.NYSE:EVRI Debt to Equity History November 14th 2021
How Strong Is Everi Holdings’ Balance Sheet?
Zooming in on the latest balance sheet data, we can see that Everi Holdings had liabilities of US$382.8m due within 12 months and liabilities of US$1.01b due beyond that. Offsetting this, it had US$221.3m in cash and US$145.8m in receivables that were due within 12 months. So its liabilities total US$1.03b more than the combination of its cash and short-term receivables.https://dec2661ce5f96361b2aa669e95f9c10a.safeframe.googlesyndication.com/safeframe/1-0-38/html/container.html
Everi Holdings has a market capitalization of US$2.21b, so it could very likely raise cash to ameliorate its balance sheet, if the need arose. But we definitely want to keep our eyes open to indications that its debt is bringing too much risk.
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.
While Everi Holdings’s debt to EBITDA ratio (2.5) suggests that it uses some debt, its interest cover is very weak, at 2.4, suggesting high leverage. So shareholders should probably be aware that interest expenses appear to have really impacted the business lately. Notably, Everi Holdings’s EBIT launched higher than Elon Musk, gaining a whopping 3,408% on last year. 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 Everi Holdings can strengthen its balance sheet over time.
Finally, a business needs free cash flow to pay off debt; accounting profits just don’t cut it. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. During the last three years, Everi Holdings generated free cash flow amounting to a very robust 93% of its EBIT, more than we’d expect. That puts it in a very strong position to pay down debt.
Our View
The good news is that Everi Holdings’s demonstrated ability to convert EBIT to free cash flow delights us like a fluffy puppy does a toddler. But the stark truth is that we are concerned by its interest cover. Looking at all the aforementioned factors together, it strikes us that Everi Holdings can handle its debt fairly comfortably. On the plus side, this leverage can boost shareholder returns, but the potential downside is more risk of loss, so it’s worth monitoring the balance sheet. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet – far from it.