Warren Buffett famously said, ‘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 888 Holdings plc (LON:888) 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 assists a business until the business has trouble paying it off, either with new capital or with free cash flow. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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, debt can be an important tool in businesses, particularly capital heavy businesses. When we examine debt levels, we first consider both cash and debt levels, together.
What Is 888 Holdings’s Debt?
The image below, which you can click on for greater detail, shows that at June 2019 888 Holdings had debt of US$32.8m, up from none in one year. But it also has US$111.0m in cash to offset that, meaning it has US$78.2m net cash.
How Strong Is 888 Holdings’s Balance Sheet?
According to the last reported balance sheet, 888 Holdings had liabilities of US$265.9m due within 12 months, and liabilities of US$21.6m due beyond 12 months. On the other hand, it had cash of US$111.0m and US$43.8m worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by US$132.7m.
This deficit isn’t so bad because 888 Holdings is worth US$648.2m, and thus could probably raise enough capital to shore up its balance sheet, if the need arose. However, it is still worthwhile taking a close look at its ability to pay off debt. Despite its noteworthy liabilities, 888 Holdings boasts net cash, so it’s fair to say it does not have a heavy debt load!
It is just as well that 888 Holdings’s load is not too heavy, because its EBIT was down 23% over the last year. Falling earnings (if the trend continues) could eventually make even modest debt quite risky. 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 888 Holdings’s ability to maintain a healthy balance sheet going forward. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.
Finally, a business needs free cash flow to pay off debt; accounting profits just don’t cut it. 888 Holdings may have net cash on the balance sheet, but it is still interesting to look at how well the business converts its earnings before interest and tax (EBIT) to free cash flow, because that will influence both its need for, and its capacity to manage debt. During the last three years, 888 Holdings produced sturdy free cash flow equating to 77% 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.
While 888 Holdings does have more liabilities than liquid assets, it also has net cash of US$78.2m. And it impressed us with free cash flow of US$46m, being 77% of its EBIT. So we don’t have any problem with 888 Holdings’s use of debt. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. Be aware that 888 Holdings is showing 1 warning sign in our investment analysis , you should know about…
If you’re interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.
If you spot an error that warrants correction, please contact the editor at firstname.lastname@example.org. This article by Simply Wall St is general in nature. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. Simply Wall St has no position in the stocks mentioned.
We aim to bring you long-term focused research analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Thank you for reading.