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. We can see that Melco Resorts & Entertainment Limited (NASDAQ:MLCO) does use debt in its business. But is this debt a concern to shareholders?
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. If things get really bad, the lenders can take control of the business. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. 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. 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 Melco Resorts & Entertainment Carry?
As you can see below, at the end of September 2021, Melco Resorts & Entertainment had US$6.16b of debt, up from US$5.64b a year ago. Click the image for more detail. However, it does have US$1.52b in cash offsetting this, leading to net debt of about US$4.64b.
How Healthy 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$998.1m due within 12 months and liabilities of US$6.66b due beyond that. Offsetting this, it had US$1.52b in cash and US$52.4m in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by US$6.08b.
When you consider that this deficiency exceeds the company's US$4.83b market capitalization, you might well be inclined to review the balance sheet intently. In the scenario where the company had to clean up its balance sheet quickly, it seems likely shareholders would suffer extensive dilution. When analysing debt levels, the balance sheet is the obvious place to start. 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 want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.
Over 12 months, Melco Resorts & Entertainment made a loss at the EBIT level, and saw its revenue drop to US$2.1b, which is a fall of 22%. To be frank that doesn't bode well.
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). Its EBIT loss was a whopping US$576m. Considering that alongside the liabilities mentioned above make us nervous about the company. It would need to improve its operations quickly for us to be interested in it. For example, we would not want to see a repeat of last year's loss of US$852m. In the meantime, we consider the stock to be risky. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. For example, we've discovered 2 warning signs for Melco Resorts & Entertainment (1 is significant!) that you should be aware of before investing here.
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.
Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.