Is Melco Resorts & Entertainment (NASDAQ:MLCO) Using Debt In A Risky Way?

The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. We note that Melco Resorts & Entertainment Limited (NASDAQ:MLCO) does have debt on its balance sheet. But should shareholders be worried about its use of debt?

What Risk Does Debt Bring?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. When we examine debt levels, we first consider both cash and debt levels, together.

Check out our latest analysis for Melco Resorts & Entertainment

What Is Melco Resorts & Entertainment's Net Debt?

The image below, which you can click on for greater detail, shows that at June 2022 Melco Resorts & Entertainment had debt of US$7.33b, up from US$6.16b in one year. However, it does have US$1.65b in cash offsetting this, leading to net debt of about US$5.68b.

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$867.7m due within 12 months and liabilities of US$7.77b due beyond that. Offsetting this, it had US$1.65b in cash and US$255.1m in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by US$6.74b.

The deficiency here weighs heavily on the US$3.04b company itself, as if a child were struggling under the weight of an enormous back-pack full of books, his sports gear, and a trumpet. So we'd watch its balance sheet closely, without a doubt. At the end of the day, Melco Resorts & Entertainment would probably need a major re-capitalization if its creditors were to demand repayment. There's no doubt that we learn most about debt from the balance sheet. But it is future earnings, more than anything, that will determine Melco Resorts & Entertainment's ability to maintain a healthy balance sheet going forward. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

Over 12 months, Melco Resorts & Entertainment made a loss at the EBIT level, and saw its revenue drop to US$1.7b, which is a fall of 7.0%. That's not what we would hope to see.

Caveat Emptor

Over the last twelve months Melco Resorts & Entertainment produced an earnings before interest and tax (EBIT) loss. Indeed, it lost a very considerable US$606m at the EBIT level. When we look at that alongside the significant liabilities, we're not particularly confident about the company. It would need to improve its operations quickly for us to be interested in it. Not least because it burned through US$948m in negative free cash flow over the last year. So suffice it to say we consider the stock to be risky. When we look at a riskier company, we like to check how their profits (or losses) are trending over time. Today, we're providing readers this interactive graph showing how Melco Resorts & Entertainment's profit, revenue, and operating cashflow have changed over the last few years.

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

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This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. 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.