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 Future Gaming Group International AB (publ) (NGM:FGG) makes use of debt. But the real question is whether this debt is making the company risky.
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. 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, plenty of companies use debt to fund growth, without any negative consequences. When we examine debt levels, we first consider both cash and debt levels, together.
What Is Future Gaming Group International's Net Debt?
You can click the graphic below for the historical numbers, but it shows that Future Gaming Group International had kr117.9m of debt in June 2020, down from kr135.9m, one year before. On the flip side, it has kr9.47m in cash leading to net debt of about kr108.4m.
How Healthy Is Future Gaming Group International's Balance Sheet?
We can see from the most recent balance sheet that Future Gaming Group International had liabilities of kr1.93m falling due within a year, and liabilities of kr118.5m due beyond that. Offsetting this, it had kr9.47m in cash and kr6.39m in receivables that were due within 12 months. So its liabilities total kr104.5m more than the combination of its cash and short-term receivables.
Given this deficit is actually higher than the company's market capitalization of kr93.0m, we think shareholders really should watch Future Gaming Group International's debt levels, like a parent watching their child ride a bike for the first time. In the scenario where the company had to clean up its balance sheet quickly, it seems likely shareholders would suffer extensive dilution.
In order to size up a company's debt relative to its earnings, we calculate its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and its earnings before interest and tax (EBIT) divided by its interest expense (its interest cover). The advantage of this approach is that we take into account both the absolute quantum of debt (with net debt to EBITDA) and the actual interest expenses associated with that debt (with its interest cover ratio).
Future Gaming Group International shareholders face the double whammy of a high net debt to EBITDA ratio (13.1), and fairly weak interest coverage, since EBIT is just 0.45 times the interest expense. The debt burden here is substantial. Worse, Future Gaming Group International's EBIT was down 49% over the last year. If earnings continue to follow that trajectory, paying off that debt load will be harder than convincing us to run a marathon in the rain. There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since Future Gaming Group International will need earnings to service that debt. So if you're keen to discover more about its earnings, it might be worth checking out this graph of its long term earnings trend.
Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. During the last three years, Future Gaming Group International burned a lot of cash. While that may be a result of expenditure for growth, it does make the debt far more risky.
To be frank both Future Gaming Group International's conversion of EBIT to free cash flow and its track record of (not) growing its EBIT make us rather uncomfortable with its debt levels. And even its net debt to EBITDA fails to inspire much confidence. We think the chances that Future Gaming Group International has too much debt a very significant. To us, that makes the stock rather risky, like walking through a dog park with your eyes closed. But some investors may feel differently. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. Like risks, for instance. Every company has them, and we've spotted 5 warning signs for Future Gaming Group International (of which 2 shouldn't be ignored!) you should know about.
If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.
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