Liberty SiriusXM Group (NASDAQ:LSXM.K) Takes On Some Risk With Its Use Of Debt

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.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. We can see that The Liberty SiriusXM Group (NASDAQ:LSXM.K) does use debt in its business. But the real question is whether this debt is making the company risky.

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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. 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 think about a company's use of debt, we first look at cash and debt together.

Check out our latest analysis for Liberty SiriusXM Group

How Much Debt Does Liberty SiriusXM Group Carry?

You can click the graphic below for the historical numbers, but it shows that as of December 2021 Liberty SiriusXM Group had US$14.3b of debt, an increase on US$13.0b, over one year. On the flip side, it has US$598.0m in cash leading to net debt of about US$13.7b.

How Healthy Is Liberty SiriusXM Group's Balance Sheet?

We can see from the most recent balance sheet that Liberty SiriusXM Group had liabilities of US$5.18b falling due within a year, and liabilities of US$14.9b due beyond that. On the other hand, it had cash of US$598.0m and US$722.0m worth of receivables due within a year. So its liabilities total US$18.8b more than the combination of its cash and short-term receivables.

When you consider that this deficiency exceeds the company's huge US$15.3b 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.

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.

Liberty SiriusXM Group has a rather high debt to EBITDA ratio of 5.3 which suggests a meaningful debt load. However, its interest coverage of 3.9 is reasonably strong, which is a good sign. On a slightly more positive note, Liberty SiriusXM Group grew its EBIT at 12% over the last year, further increasing its ability to manage 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 Liberty SiriusXM Group'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, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So we always check how much of that EBIT is translated into free cash flow. During the last three years, Liberty SiriusXM Group generated free cash flow amounting to a very robust 87% of its EBIT, more than we'd expect. That puts it in a very strong position to pay down debt.

Our View

Liberty SiriusXM Group's net debt to EBITDA and level of total liabilities definitely weigh on it, in our esteem. But the good news is it seems to be able to convert EBIT to free cash flow with ease. When we consider all the factors discussed, it seems to us that Liberty SiriusXM Group is taking some risks with its use of debt. While that debt can boost returns, we think the company has enough leverage now. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. These risks can be hard to spot. Every company has them, and we've spotted 1 warning sign for Liberty SiriusXM Group you should know about.

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.

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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.