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.' 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. As with many other companies Enthusiast Gaming Holdings Inc. (TSE:EGLX) makes use of debt. But is this debt a concern to shareholders?
When Is Debt A Problem?
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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. When we think about a company's use of debt, we first look at cash and debt together.
What Is Enthusiast Gaming Holdings's Net Debt?
As you can see below, at the end of September 2020, Enthusiast Gaming Holdings had CA$35.4m of debt, up from CA$11.1m a year ago. Click the image for more detail. On the flip side, it has CA$8.65m in cash leading to net debt of about CA$26.7m.
How Healthy Is Enthusiast Gaming Holdings's Balance Sheet?
The latest balance sheet data shows that Enthusiast Gaming Holdings had liabilities of CA$22.3m due within a year, and liabilities of CA$57.3m falling due after that. Offsetting these obligations, it had cash of CA$8.65m as well as receivables valued at CA$17.7m due within 12 months. So it has liabilities totalling CA$53.2m more than its cash and near-term receivables, combined.
Given Enthusiast Gaming Holdings has a market capitalization of CA$371.5m, it's hard to believe these liabilities pose much threat. But there are sufficient liabilities that we would certainly recommend shareholders continue to monitor the balance sheet, going forward. 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 Enthusiast Gaming Holdings can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.
Over 12 months, Enthusiast Gaming Holdings reported revenue of CA$40m, which is a gain of 1,177%, although it did not report any earnings before interest and tax. When it comes to revenue growth, that's like nailing the game winning 3-pointer!
While we can certainly appreciate Enthusiast Gaming Holdings's revenue growth, its earnings before interest and tax (EBIT) loss is not ideal. Indeed, it lost CA$25m at the EBIT level. When we look at that and recall the liabilities on its balance sheet, relative to cash, it seems unwise to us for the company to have any debt. So we think its balance sheet is a little strained, though not beyond repair. Another cause for caution is that is bled CA$19m in negative free cash flow over the last twelve months. So in short it's a really risky stock. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. Consider for instance, the ever-present spectre of investment risk. We've identified 4 warning signs with Enthusiast Gaming Holdings , and understanding them should be part of your investment process.
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.
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