Berkshire Hathaway’s Charlie Munger-backed external fund manager Li Lu is quick to say so when he says “The biggest risk in investing is not price volatility, but if you will suffer a loss. permanent capital “. It is only natural to consider a company’s balance sheet when considering how risky it is, as debt is often involved when a business collapses. We can see that International Game Technology PLC (NYSE: IGT) uses debt in its business. But should shareholders be concerned about its use of debt?
Why Does Debt Bring Risk?
Generally speaking, debt only becomes a real problem when a company cannot repay it easily, either by raising capital or with its own cash flow. An integral part of capitalism is the process of “creative destruction” where bankrupt companies are ruthlessly liquidated by their bankers. While it’s not too common, we often see indebted companies continually diluting their shareholders because lenders are forcing them to raise capital at a ridiculous price. Of course, debt can be an important tool in businesses, especially capital intensive businesses. The first step in examining a company’s debt levels is to consider its cash flow and debt together.
What is International Game Technology’s debt?
As you can see below, International Game Technology had $ 6.56 billion in debt in September 2021, up from $ 8.20 billion the year before. On the other hand, it has $ 435.0 million in cash, resulting in net debt of around $ 6.13 billion.
NYSE: IGT Debt to Equity History November 21, 2021
A look at the responsibilities of International Game Technology
Zooming in on the latest balance sheet data, we can see that International Game Technology had a liability of $ 1.83 billion due within 12 months and a liability of $ 7.53 billion due beyond. . In return, he had $ 435.0 million in cash and $ 1.26 billion in receivables due within 12 months. It therefore has liabilities totaling US $ 7.66 billion more than its cash and short-term receivables combined.
Given that this deficit is actually greater than the company’s market cap of $ 5.66 billion, we think shareholders should really watch International Game Technology’s debt levels, like a parent watching their child riding a bicycle for the first time. Hypothetically, extremely high dilution would be required if the company were forced to repay its debts by raising capital at the current share price.
We measure a company’s indebtedness relative to its earning power by looking at its net debt divided by its earnings before interest, taxes, depreciation, and amortization (EBITDA) and calculating the ease with which its earnings before interest and taxes (EBIT ) covers its interests. costs (interest coverage). The advantage of this approach is that we take into account both the absolute amount of debt (with net debt versus EBITDA) and the actual interest charges associated with this debt (with its coverage rate). interests).
While we’re not worried about International Game Technology’s net debt to EBITDA ratio of 4.6, we believe its ultra-low 2.2x interest coverage is a sign of high leverage. Shareholders should therefore probably be aware that interest charges seem to have had a real impact on the company in recent times. The silver lining is that International Game Technology increased its EBIT by 397% last year, which nurtures like idealism among the youth. If he can continue on this path, he will be able to deleverage with relative ease. There is no doubt that we learn the most about debt from the balance sheet. But ultimately, the company’s future profitability will decide whether International Game Technology can strengthen its balance sheet over time. So if you want to see what the professionals are thinking, you might find this free report on analysts’ earnings forecasts Be interesting.
Finally, while the IRS may love accounting profits, lenders only accept hard cash. It is therefore worth checking to what extent this EBIT is supported by free cash flow. Over the past three years, International Game Technology has recorded free cash flow totaling 81% of its EBIT, which is higher than what we usually expected. This positions it well to repay debt if it is desirable.
Our point of view
We feel some trepidation about the difficulty level of International Game Technology’s total liabilities, but we also have some bright spots to focus on. Its conversion of EBIT to free cash flow and the growth rate of EBIT were encouraging signs. Looking at all of the angles mentioned above, it seems to us that International Game Technology is a somewhat risky investment due to its leverage. Not all risks are bad, as they can increase stock returns if they are profitable, but this risk of leverage is worth keeping in mind. When analyzing debt levels, the balance sheet is the obvious starting point. But at the end of the day, every business can contain risks that exist off the balance sheet. For example, we have identified 2 warning signs for International Game Technology that you need to be aware of.
If you want to invest in companies that can generate profits without the burden of debt, check out this free list of growing companies that have net cash on the balance sheet.
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