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. We can see that easyJet plc (LON:EZJ) does use debt in its business. But the real question is whether this debt is making the company risky.
Why Does Debt Bring Risk?
Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.
How Much Debt Does easyJet Carry?
The image below, which you can click on for greater detail, shows that at September 2020 easyJet had debt of UK£2.73b, up from UK£1.33b in one year. However, it does have UK£2.32b in cash offsetting this, leading to net debt of about UK£415.0m.
How Healthy Is easyJet's Balance Sheet?
Zooming in on the latest balance sheet data, we can see that easyJet had liabilities of UK£3.83b due within 12 months and liabilities of UK£2.75b due beyond that. On the other hand, it had cash of UK£2.32b and UK£115.0m worth of receivables due within a year. So its liabilities total UK£4.14b more than the combination of its cash and short-term receivables.
This deficit is considerable relative to its market capitalization of UK£4.24b, so it does suggest shareholders should keep an eye on easyJet's use of debt. Should its lenders demand that it shore up the balance sheet, shareholders would likely face severe dilution. There's no doubt that we learn most about debt from the balance sheet. But ultimately the future profitability of the business will decide if easyJet 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.
In the last year easyJet had a loss before interest and tax, and actually shrunk its revenue by 53%, to UK£3.0b. To be frank that doesn't bode well.
While easyJet's falling revenue is about as heartwarming as a wet blanket, arguably its earnings before interest and tax (EBIT) loss is even less appealing. Indeed, it lost a very considerable UK£777m 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 UK£1.3b in negative free cash flow over the last twelve months. So in short it's a really risky stock. 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 3 warning signs for easyJet you should be aware of, and 1 of them shouldn't be ignored.
When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.
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