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. 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. As with many other companies Fidelity National Information Services, Inc. (NYSE:FIS) makes use of debt. But the more important question is: how much risk is that debt creating?
Why Does Debt Bring Risk?
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. If things get really bad, the lenders can take control of the business. 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. Of course, plenty of companies use debt to fund growth, without any negative consequences. When we think about a company’s use of debt, we first look at cash and debt together.
How Much Debt Does Fidelity National Information Services Carry?
You can click the graphic below for the historical numbers, but it shows that as of September 2019 Fidelity National Information Services had US$20.2b of debt, an increase on US$9.0k, over one year. However, it does have US$1.31b in cash offsetting this, leading to net debt of about US$18.9b.
How Strong Is Fidelity National Information Services’s Balance Sheet?
Zooming in on the latest balance sheet data, we can see that Fidelity National Information Services had liabilities of US$10.9b due within 12 months and liabilities of US$23.6b due beyond that. Offsetting this, it had US$1.31b in cash and US$3.49b in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by US$29.7b.
Fidelity National Information Services has a very large market capitalization of US$87.2b, so it could very likely raise cash to ameliorate its balance sheet, if the need arose. But we definitely want to keep our eyes open to indications that its debt is bringing too much risk.
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).
Fidelity National Information Services has a rather high debt to EBITDA ratio of 6.7 which suggests a meaningful debt load. However, its interest coverage of 5.0 is reasonably strong, which is a good sign. Unfortunately, Fidelity National Information Services saw its EBIT slide 3.9% in the last twelve months. If that earnings trend continues then its debt load will grow heavy like the heart of a polar bear watching its sole cub. 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 Fidelity National Information Services 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 clearly need to look at whether that EBIT is leading to corresponding free cash flow. Over the last three years, Fidelity National Information Services recorded free cash flow worth a fulsome 87% of its EBIT, which is stronger than we’d usually expect. That puts it in a very strong position to pay down debt.
Based on what we’ve seen Fidelity National Information Services is not finding it easy, given its net debt to EBITDA, but the other factors we considered give us cause to be optimistic. In particular, we are dazzled with its conversion of EBIT to free cash flow. Looking at all this data makes us feel a little cautious about Fidelity National Information Services’s debt levels. While we appreciate debt can enhance returns on equity, we’d suggest that shareholders keep close watch on its debt levels, lest they increase. We’d be motivated to research the stock further if we found out that Fidelity National Information Services 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.
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.
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