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. As with many other companies Melco Resorts & Entertainment Limited (NASDAQ:MLCO) makes use of debt. But should shareholders be worried about its use of debt?
When Is Debt A Problem?
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. 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. 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 thing to do when considering how much debt a business uses is to look at its cash and debt together.
What Is Melco Resorts & Entertainment's Net Debt?
As you can see below, at the end of September 2020, Melco Resorts & Entertainment had US$5.64b of debt, up from US$4.74b a year ago. Click the image for more detail. On the flip side, it has US$1.92b in cash leading to net debt of about US$3.72b.
How Strong Is Melco Resorts & Entertainment's Balance Sheet?
Zooming in on the latest balance sheet data, we can see that Melco Resorts & Entertainment had liabilities of US$1.30b due within 12 months and liabilities of US$5.81b due beyond that. Offsetting these obligations, it had cash of US$1.92b as well as receivables valued at US$142.8m due within 12 months. So it has liabilities totalling US$5.05b more than its cash and near-term receivables, combined.
This deficit isn't so bad because Melco Resorts & Entertainment is worth US$8.91b, and thus could probably raise enough capital to shore up its balance sheet, if the need arose. However, it is still worthwhile taking a close look at its ability to pay off debt. 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 Melco Resorts & Entertainment 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 Melco Resorts & Entertainment had a loss before interest and tax, and actually shrunk its revenue by 53%, to US$2.7b. That makes us nervous, to say the least.
Not only did Melco Resorts & Entertainment's revenue slip over the last twelve months, but it also produced negative earnings before interest and tax (EBIT). Indeed, it lost US$618m at the EBIT level. Considering that alongside the liabilities mentioned above does not give us much confidence that company should be using so much debt. Quite frankly we think the balance sheet is far from match-fit, although it could be improved with time. For example, we would not want to see a repeat of last year's loss of US$996m. So we do think this stock is quite risky. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. For instance, we've identified 2 warning signs for Melco Resorts & Entertainment (1 makes us a bit uncomfortable) 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.
When trading Melco Resorts & Entertainment or any other investment, use the platform considered by many to be the Professional's Gateway to the Worlds Market, Interactive Brokers. You get the lowest-cost* trading on stocks, options, futures, forex, bonds and funds worldwide from a single integrated account.
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. 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.
*Interactive Brokers Rated Lowest Cost Broker by StockBrokers.com Annual Online Review 2020
Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.