Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that ‘Volatility is far from synonymous with risk.’ It’s only natural to consider a company’s balance sheet when you examine how risky it is, since debt is often involved when a business collapses. We note that MGM Resorts International (NYSE:MGM) does have debt on its balance sheet. But the more important question is: how much risk is that debt creating?
Why Does Debt Bring Risk?
Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. Part and parcel of capitalism is the process of ‘creative destruction’ where failed businesses are mercilessly liquidated by their bankers. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. Of course, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. The first step when considering a company’s debt levels is to consider its cash and debt together.
What Is MGM Resorts International’s Debt?
You can click the graphic below for the historical numbers, but it shows that as of September 2021 MGM Resorts International had US$12.7b of debt, an increase on US$11.5b, over one year. However, it does have US$5.57b in cash offsetting this, leading to net debt of about US$7.12b.
How Healthy Is MGM Resorts International’s Balance Sheet?
We can see from the most recent balance sheet that MGM Resorts International had liabilities of US$3.41b falling due within a year, and liabilities of US$26.1b due beyond that. Offsetting these obligations, it had cash of US$5.57b as well as receivables valued at US$731.3m due within 12 months. So its liabilities total US$23.3b more than the combination of its cash and short-term receivables.
When you consider that this deficiency exceeds the company’s huge US$21.2b market capitalization, you might well be inclined to review the balance sheet intently. Hypothetically, extremely heavy dilution would be required if the company were forced to pay down its liabilities by raising capital at the current share price. 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 MGM Resorts International can strengthen its balance sheet over time.
In the last year MGM Resorts International wasn’t profitable at an EBIT level, but managed to grow its revenue by 18%, to US$7.8b. That rate of growth is a bit slow for our taste, but it takes all types to make a world.
Over the last twelve months MGM Resorts International produced an earnings before interest and tax (EBIT) loss. Indeed, it lost US$74m at the EBIT level. When we look at that alongside the significant liabilities, we’re not particularly confident about the company. We’d want to see some strong near-term improvements before getting too interested in the stock. But on the bright side the company actually produced a statutory profit of US$615m and free cash flow of US$228m. So one might argue that there’s still a chance it can get things on the right track. The balance sheet is clearly the area to focus on when you are analysing debt.