Is ZAGG (NASDAQ:ZAGG) A Risky Investment?

Want to participate in a short research study? Help shape the future of investing tools and you could win a $250 gift card!

David Iben put it well when he said, ‘Volatility is not a risk we care about. What we care about is avoiding the 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, ZAGG Inc (NASDAQ:ZAGG) does carry debt. But the real question is whether this debt is making the company risky.

When Is Debt Dangerous?

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. Of course, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. When we examine debt levels, we first consider both cash and debt levels, together.

View our latest analysis for ZAGG

What Is ZAGG’s Net Debt?

The image below, which you can click on for greater detail, shows that at March 2019 ZAGG had debt of US$93.4m, up from US$22.0m in one year. However, because it has a cash reserve of US$14.8m, its net debt is less, at about US$78.6m.

NasdaqGS:ZAGG Historical Debt, July 16th 2019
NasdaqGS:ZAGG Historical Debt, July 16th 2019

How Healthy Is ZAGG’s Balance Sheet?

Zooming in on the latest balance sheet data, we can see that ZAGG had liabilities of US$106.8m due within 12 months and liabilities of US$113.4m due beyond that. Offsetting these obligations, it had cash of US$14.8m as well as receivables valued at US$95.8m due within 12 months. So it has liabilities totalling US$109.7m more than its cash and near-term receivables, combined.

While this might seem like a lot, it is not so bad since ZAGG has a market capitalization of US$212.5m, and so it could probably strengthen its balance sheet by raising capital if it needed to. But we definitely want to keep our eyes open to indications that its debt is bringing too much risk. Because it carries more debt than cash, we think it’s worth watching ZAGG’s balance sheet over time.

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).

We’d say that ZAGG’s moderate net debt to EBITDA ratio ( being 1.64), indicates prudence when it comes to debt. And its strong interest cover of 13.1 times, makes us even more comfortable. Importantly, ZAGG’s EBIT fell a jaw-dropping 46% in the last twelve months. If that decline continues then paying off debt will be harder than selling foie gras at a vegan convention. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if ZAGG can strengthen its balance sheet over time. So if you’re focused on the future you can check out this free report showing analyst profit forecasts.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. Over the most recent three years, ZAGG recorded free cash flow worth 73% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This cold hard cash means it can reduce its debt when it wants to.

Our View

While ZAGG’s EBIT growth rate has us nervous. For example, its interest cover and conversion of EBIT to free cash flow give us some confidence in its ability to manage its debt. Looking at all the angles mentioned above, it does seem to us that ZAGG is a somewhat risky investment as a result of its debt. That’s not necessarily a bad thing, since leverage can boost returns on equity, but it is something to be aware of. Over time, share prices tend to follow earnings per share, so if you’re interested in ZAGG, you may well want to click here to check an interactive graph of its earnings per share history.

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.

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.

If you spot an error that warrants correction, please contact the editor at editorial-team@simplywallst.com. 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. Thank you for reading.