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 Wynn Resorts, Limited (NASDAQ:WYNN) does have debt on its balance sheet. But the more important question is: how much risk is that debt creating?
What Risk Does Debt Bring?
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. 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, plenty of companies use debt to fund growth, without any negative consequences. The first step when considering a company's debt levels is to consider its cash and debt together.
View our latest analysis for Wynn Resorts
What Is Wynn Resorts's Net Debt?
You can click the graphic below for the historical numbers, but it shows that as of December 2019 Wynn Resorts had US$10.4b of debt, an increase on US$9.42b, over one year. On the flip side, it has US$2.35b in cash leading to net debt of about US$8.06b.
How Healthy Is Wynn Resorts's Balance Sheet?
The latest balance sheet data shows that Wynn Resorts had liabilities of US$1.98b due within a year, and liabilities of US$10.3b falling due after that. Offsetting this, it had US$2.35b in cash and US$346.4m in receivables that were due within 12 months. So its liabilities total US$9.63b more than the combination of its cash and short-term receivables.
This deficit casts a shadow over the US$5.55b company, like a colossus towering over mere mortals. So we definitely think shareholders need to watch this one closely. At the end of the day, Wynn Resorts would probably need a major re-capitalization if its creditors were to demand repayment.
We use two main ratios to inform us about debt levels relative to earnings. The first is net debt divided by earnings before interest, tax, depreciation, and amortization (EBITDA), while the second is how many times its earnings before interest and tax (EBIT) covers its interest expense (or its interest cover, for short). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.
Weak interest cover of 2.3 times and a disturbingly high net debt to EBITDA ratio of 5.3 hit our confidence in Wynn Resorts like a one-two punch to the gut. This means we'd consider it to have a heavy debt load. Worse, Wynn Resorts's EBIT was down 29% over the last year. If earnings keep going like that over the long term, it has a snowball's chance in hell of paying off that debt. 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 Wynn Resorts'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.
Finally, a company can only pay off debt with cold hard cash, not accounting profits. So the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. Over the last three years, Wynn Resorts reported free cash flow worth 3.7% of its EBIT, which is really quite low. That limp level of cash conversion undermines its ability to manage and pay down debt.
Our View
To be frank both Wynn Resorts's EBIT growth rate and its track record of staying on top of its total liabilities make us rather uncomfortable with its debt levels. And even its interest cover fails to inspire much confidence. We think the chances that Wynn Resorts 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. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. For instance, we've identified 4 warning signs for Wynn Resorts (1 makes us a bit uncomfortable) you should be aware of.
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.
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.
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