Legendary fund manager Li Lu (who Charlie Munger backed) once said, ‘The biggest investment risk is not the volatility of prices, but whether you will suffer a 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. We note that Nexstar Media Group, Inc. (NASDAQ:NXST) does have debt on its balance sheet. But should shareholders be worried about its use of debt?

What Risk Does Debt Bring?

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. If things get really bad, the lenders can take control of the business. 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, plenty of companies use debt to fund growth, without any negative consequences. When we examine debt levels, we first consider both cash and debt levels, together.

How Much Debt Does Nexstar Media Group Carry?

The image below, which you can click on for greater detail, shows that Nexstar Media Group had debt of US$7.55b at the end of September 2021, a reduction from US$7.88b over a year. However, it also had US$193.8m in cash, and so its net debt is US$7.35b.

A Look At Nexstar Media Group’s Liabilities

The latest balance sheet data shows that Nexstar Media Group had liabilities of US$711.0m due within a year, and liabilities of US$9.94b falling due after that. Offsetting these obligations, it had cash of US$193.8m as well as receivables valued at US$923.0m due within 12 months. So it has liabilities totalling US$9.53b more than its cash and near-term receivables, combined.

The deficiency here weighs heavily on the US$6.24b company itself, as if a child were struggling under the weight of an enormous back-pack full of books, his sports gear, and a trumpet. So we definitely think shareholders need to watch this one closely. At the end of the day, Nexstar Media Group would probably need a major re-capitalization if its creditors were to demand repayment.

In order to size up a company’s debt relative to its earnings, we calculate its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and its earnings before interest and tax (EBIT) divided by its interest expense (its interest cover). The advantage of this approach is that we take into account both the absolute quantum of debt (with net debt to EBITDA) and the actual interest expenses associated with that debt (with its interest cover ratio).

Nexstar Media Group has a debt to EBITDA ratio of 3.9 and its EBIT covered its interest expense 5.0 times. This suggests that while the debt levels are significant, we’d stop short of calling them problematic. Also relevant is that Nexstar Media Group has grown its EBIT by a very respectable 26% in the last year, thus enhancing its ability to pay down debt. There’s no doubt that we learn most about debt from the balance sheet. But it is future earnings, more than anything, that will determine Nexstar Media Group’s ability to maintain a healthy balance sheet going forward.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So it’s worth checking how much of that EBIT is backed by free cash flow. During the last three years, Nexstar Media Group produced sturdy free cash flow equating to 68% of its EBIT, about what we’d expect. This free cash flow puts the company in a good position to pay down debt, when appropriate.

Our View

Nexstar Media Group’s level of total liabilities was a real negative on this analysis, although the other factors we considered cast it in a significantly better light. For example its EBIT growth rate was refreshing. When we consider all the factors discussed, it seems to us that Nexstar Media Group is taking some risks with its use of debt. So while that leverage does boost returns on equity, we wouldn’t really want to see it increase from here.