Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' 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. As with many other companies Cumulus Media Inc. (NASDAQ:CMLS) makes use of debt. But the real question is whether this debt is making the company risky.
When Is Debt A Problem?
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 frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. Of course, plenty of companies use debt to fund growth, without any negative consequences. When we examine debt levels, we first consider both cash and debt levels, together.
How Much Debt Does Cumulus Media Carry?
The chart below, which you can click on for greater detail, shows that Cumulus Media had US$972.9m in debt in December 2020; about the same as the year before. However, it also had US$271.8m in cash, and so its net debt is US$701.2m.
A Look At Cumulus Media's Liabilities
We can see from the most recent balance sheet that Cumulus Media had liabilities of US$129.0m falling due within a year, and liabilities of US$1.33b due beyond that. On the other hand, it had cash of US$271.8m and US$203.3m worth of receivables due within a year. So it has liabilities totalling US$987.1m more than its cash and near-term receivables, combined.
The deficiency here weighs heavily on the US$173.2m 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, Cumulus Media would probably need a major re-capitalization if its creditors were to demand repayment.
We measure a company's debt load relative to its earnings power by looking at its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and by calculating how easily its earnings before interest and tax (EBIT) cover its interest expense (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).
Weak interest cover of 0.32 times and a disturbingly high net debt to EBITDA ratio of 9.5 hit our confidence in Cumulus Media like a one-two punch to the gut. The debt burden here is substantial. Even worse, Cumulus Media saw its EBIT tank 86% over the last 12 months. If earnings continue to follow that trajectory, paying off that debt load will be harder than convincing us to run a marathon in the rain. 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 Cumulus Media'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.
But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. In the last three years, Cumulus Media's free cash flow amounted to 36% of its EBIT, less than we'd expect. That's not great, when it comes to paying down debt.
On the face of it, Cumulus Media's EBIT growth rate left us tentative about the stock, and its level of total liabilities was no more enticing than the one empty restaurant on the busiest night of the year. Having said that, its ability to convert EBIT to free cash flow isn't such a worry. We think the chances that Cumulus Media has too much debt a very significant. To our minds, that means the stock is rather high risk, and probably one to avoid; but to each their own (investing) style. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. Case in point: We've spotted 1 warning sign for Cumulus Media you should be aware of.
When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.
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