Legendary fund manager Li Lu (who Charlie Munger backed) once said, ‘The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital. So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. We note that Endurance International Group Holdings, Inc. (NASDAQ:EIGI) does have debt on its balance sheet. But is this debt a concern to shareholders?
When Is Debt A Problem?
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. 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. 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 Endurance International Group Holdings Carry?
You can click the graphic below for the historical numbers, but it shows that as of September 2019 Endurance International Group Holdings had US$1.73b of debt, an increase on US$1.8k, over one year. On the flip side, it has US$84.5m in cash leading to net debt of about US$1.65b.
How Healthy Is Endurance International Group Holdings’s Balance Sheet?
According to the last reported balance sheet, Endurance International Group Holdings had liabilities of US$530.6m due within 12 months, and liabilities of US$1.91b due beyond 12 months. Offsetting this, it had US$84.5m in cash and US$12.1m in receivables that were due within 12 months. So its liabilities total US$2.35b more than the combination of its cash and short-term receivables.
This deficit casts a shadow over the US$701.3m company, like a colossus towering over mere mortals. So we’d watch its balance sheet closely, without a doubt. At the end of the day, Endurance International Group Holdings 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).
Endurance International Group Holdings shareholders face the double whammy of a high net debt to EBITDA ratio (5.9), and fairly weak interest coverage, since EBIT is just 1.00 times the interest expense. This means we’d consider it to have a heavy debt load. Even more troubling is the fact that Endurance International Group Holdings actually let its EBIT decrease by 5.9% over the last year. If it keeps going like that paying off its debt will be like running on a treadmill — a lot of effort for not much advancement. 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 Endurance International Group Holdings can strengthen its balance sheet over time. 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 we always check how much of that EBIT is translated into free cash flow. Over the last three years, Endurance International Group Holdings actually produced more free cash flow than EBIT. That sort of strong cash generation warms our hearts like a puppy in a bumblebee suit.
On the face of it, Endurance International Group Holdings’s interest cover 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. But at least it’s pretty decent at converting EBIT to free cash flow; that’s encouraging. We’re quite clear that we consider Endurance International Group Holdings to be really rather risky, as a result of its balance sheet health. For this reason we’re pretty cautious about the stock, and we think shareholders should keep a close eye on its liquidity. While Endurance International Group Holdings didn’t make a statutory profit in the last year, its positive EBIT suggests that profitability might not be far away. Click here to see if its earnings are heading in the right direction, over the medium term.
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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