Is Tabcorp Holdings (ASX:TAH) Using Debt In A Risky Way?

The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says '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. Importantly, Tabcorp Holdings Limited (ASX:TAH) does carry debt. But is this debt a concern to shareholders?

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. 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. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. The first step when considering a company's debt levels is to consider its cash and debt together.

Check out our latest analysis for Tabcorp Holdings

What Is Tabcorp Holdings's Debt?

The image below, which you can click on for greater detail, shows that at June 2024 Tabcorp Holdings had debt of AU$1.03b, up from AU$431.9m in one year. However, it also had AU$313.7m in cash, and so its net debt is AU$718.9m.

How Strong Is Tabcorp Holdings' Balance Sheet?

The latest balance sheet data shows that Tabcorp Holdings had liabilities of AU$666.6m due within a year, and liabilities of AU$1.47b falling due after that. On the other hand, it had cash of AU$313.7m and AU$173.9m worth of receivables due within a year. So its liabilities total AU$1.65b more than the combination of its cash and short-term receivables.

When you consider that this deficiency exceeds the company's AU$1.36b market capitalization, you might well be inclined to review the balance sheet intently. In the scenario where the company had to clean up its balance sheet quickly, it seems likely shareholders would suffer extensive dilution. 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 Tabcorp Holdings's ability to maintain a healthy balance sheet going forward. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

In the last year Tabcorp Holdings had a loss before interest and tax, and actually shrunk its revenue by 4.5%, to AU$2.4b. That's not what we would hope to see.

Caveat Emptor

Importantly, Tabcorp Holdings had an earnings before interest and tax (EBIT) loss over the last year. To be specific the EBIT loss came in at AU$48m. 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. Not least because it burned through AU$515m in negative free cash flow over the last year. That means it's on the risky side of things. 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. Case in point: We've spotted 2 warning signs for Tabcorp Holdings you should be aware of.

At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.

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This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.