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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 E.W. Scripps Company (NASDAQ:SSP) does use debt in its business. But is this debt a concern to shareholders?
Why Does Debt Bring Risk?
Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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. Having said that, the most common situation is where a company manages its debt reasonably well – and to its own advantage. When we think about a company’s use of debt, we first look at cash and debt together.
What Is E.W. Scripps’s Net Debt?
The chart below, which you can click on for greater detail, shows that E.W. Scripps had US$688.3m in debt in March 2019; about the same as the year before. However, it also had US$14.4m in cash, and so its net debt is US$673.9m.
A Look At E.W. Scripps’s Liabilities
Zooming in on the latest balance sheet data, we can see that E.W. Scripps had liabilities of US$197.9m due within 12 months and liabilities of US$1.06b due beyond that. On the other hand, it had cash of US$14.4m and US$301.3m worth of receivables due within a year. So it has liabilities totalling US$940.9m more than its cash and near-term receivables, combined.
This deficit is considerable relative to its market capitalization of US$1.25b, so it does suggest shareholders should keep an eye on E.W. Scripps’s use of debt. So should its lenders demand that it shore up the balance sheet, shareholders would likely face severe dilution. Either way, since E.W. Scripps 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.
E.W. Scripps has a debt to EBITDA ratio of 3.18 and its EBIT covered its interest expense 4.01 times. Taken together this implies that, while we wouldn’t want to see debt levels rise, we think it can handle its current leverage. The silver lining is that E.W. Scripps grew its EBIT by 385% last year, which nourishing like the idealism of youth. If that earnings trend continues it will make its debt load much more manageable in the future. There’s no doubt that we learn most about debt from the balance sheet. But ultimately the future profitability of the business will decide if E.W. Scripps can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.
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. During the last three years, E.W. Scripps produced sturdy free cash flow equating to 67% of its EBIT, about what we’d expect. This free cash flow puts the company in a good position to pay down debt, when appropriate.
When it comes to the balance sheet, the standout positive for E.W. Scripps was the fact that it seems able to grow its EBIT confidently. But the other factors we noted above weren’t so encouraging. For instance it seems like it has to struggle a bit to handle its total liabilities. When we consider all the elements mentioned above, it seems to us that E.W. Scripps is managing its debt quite well. But a word of caution: we think debt levels are high enough to justify ongoing monitoring. We’d be motivated to research the stock further if we found out that E.W. Scripps insiders have bought shares recently. If you would too, then you’re in luck, since today we’re sharing our list of reported insider transactions for free.
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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If you spot an error that warrants correction, please contact the editor at firstname.lastname@example.org. 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. Thank you for reading.