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. Importantly, Hemisphere Media Group, Inc. (NASDAQ:HMTV) does carry debt. But should shareholders be worried about its use of debt?
What Risk Does Debt Bring?
Generally speaking, debt only becomes a real problem when a company can’t easily pay it off, either by raising capital or with its own cash flow. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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. Having said that, the most common situation is where a company manages its debt reasonably well – and to its own advantage. When we examine debt levels, we first consider both cash and debt levels, together.
How Much Debt Does Hemisphere Media Group Carry?
As you can see below, Hemisphere Media Group had US$205.7m of debt, at March 2019, which is about the same the year before. You can click the chart for greater detail. On the flip side, it has US$86.2m in cash leading to net debt of about US$119.5m.
How Strong Is Hemisphere Media Group’s Balance Sheet?
The latest balance sheet data shows that Hemisphere Media Group had liabilities of US$36.1m due within a year, and liabilities of US$229.4m falling due after that. Offsetting this, it had US$86.2m in cash and US$30.1m in receivables that were due within 12 months. So it has liabilities totalling US$149.2m more than its cash and near-term receivables, combined.
Hemisphere Media Group has a market capitalization of US$492.3m, so it could very likely ameliorate its balance sheet if the need arose. But it’s clear that we should definitely closely examine whether it can manage its debt without dilution. Either way, since Hemisphere Media Group does have more debt than cash, it’s worth keeping an eye on its balance sheet.
In order to size up a company’s debt relative to its earnings, we calculate its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and its earnings before interest and tax (EBIT) divided by its interest expense (its interest cover). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.
Hemisphere Media Group has net debt worth 1.77 times EBITDA, which isn’t too much, but its interest cover looks a bit on the low side, with EBIT at only 4.22 times the interest expense. While these numbers do not alarm us, it’s worth noting that the cost of the company’s debt is having a real impact. Pleasingly, Hemisphere Media Group is growing its EBIT faster than former Australian PM Bob Hawke downs a yard glass, boasting a 110% gain in the last twelve months. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Hemisphere Media Group’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.
Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So it’s worth checking how much of that EBIT is backed by free cash flow. During the last three years, Hemisphere Media Group produced sturdy free cash flow equating to 67% of its EBIT, about what we’d expect. This cold hard cash means it can reduce its debt when it wants to.
Happily, Hemisphere Media Group’s impressive EBIT growth rate implies it has the upper hand on its debt. But truth be told we feel its interest cover does undermine this impression a bit. When we consider the range of factors above, it looks like Hemisphere Media Group is pretty sensible with its use of debt. That means they are taking on a bit more risk, in the hope of boosting shareholder returns. Even though Hemisphere Media Group lost money on the bottom line, its positive EBIT suggests the business itself has potential. So you might want to check outhow earnings have been trending 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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