Does Alliance Data Systems (NYSE:ADS) Have A Healthy Balance Sheet?

By
Simply Wall St
Published
September 29, 2021
NYSE:BFH
Source: Shutterstock

David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the 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. Importantly, Alliance Data Systems Corporation (NYSE:ADS) does carry debt. But the more important question is: how much risk is that debt creating?

When Is Debt Dangerous?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. 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.

See our latest analysis for Alliance Data Systems

What Is Alliance Data Systems's Debt?

The image below, which you can click on for greater detail, shows that Alliance Data Systems had debt of US$17.0b at the end of June 2021, a reduction from US$19.4b over a year. However, it does have US$3.00b in cash offsetting this, leading to net debt of about US$14.0b.

debt-equity-history-analysis
NYSE:ADS Debt to Equity History September 29th 2021

How Strong Is Alliance Data Systems' Balance Sheet?

According to the last reported balance sheet, Alliance Data Systems had liabilities of US$10.6b due within 12 months, and liabilities of US$9.19b due beyond 12 months. Offsetting this, it had US$3.00b in cash and US$369.0m in receivables that were due within 12 months. So its liabilities total US$16.4b more than the combination of its cash and short-term receivables.

This deficit casts a shadow over the US$5.12b company, like a colossus towering over mere mortals. So we definitely think shareholders need to watch this one closely. At the end of the day, Alliance Data Systems 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). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

Strangely Alliance Data Systems has a sky high EBITDA ratio of 10.4, implying high debt, but a strong interest coverage of 10.7. So either it has access to very cheap long term debt or that interest expense is going to grow! It is well worth noting that Alliance Data Systems's EBIT shot up like bamboo after rain, gaining 71% in the last twelve months. That'll make it easier to manage its debt. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately the future profitability of the business will decide if Alliance Data Systems 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, 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. Happily for any shareholders, Alliance Data Systems actually produced more free cash flow than EBIT over the last three years. There's nothing better than incoming cash when it comes to staying in your lenders' good graces.

Our View

We feel some trepidation about Alliance Data Systems's difficulty level of total liabilities, but we've got positives to focus on, too. For example, its conversion of EBIT to free cash flow and EBIT growth rate give us some confidence in its ability to manage its debt. Looking at all the angles mentioned above, it does seem to us that Alliance Data Systems is a somewhat risky investment as a result of its debt. Not all risk is bad, as it can boost share price returns if it pays off, but this debt risk is worth keeping in mind. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. Case in point: We've spotted 3 warning signs for Alliance Data Systems you should be aware of, and 2 of them are significant.

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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